Fiscal policy is the medium the federal government controls the budget position with the aim of stabilizing prices, promoting economic growth and creating employment. Fiscal policy tools include change in level of government expenditure, change in taxes and transfer payments or a combination of all the three according to Samuelson et al (110). Fiscal policy is divided into 2 categories: discretionary fiscal policy and non discretionary.
Discretionary fiscal is initiated by the president in conjunction with congress by increasing or decreasing taxes. Discretionary fiscal policy can either be expansionary or contractionary “[sic].” Non discretionary fiscal policy is self triggered by the state. The United States has adopted a progressive tax system where the amount of tax paid is dependent on income. The higher the income, the higher the tax paid.
Monetary policy on the other hand, is a tool used by central banks to manage liquidity in an economy. Liquidity is defined as the total of money in circulation in an economy at any given time. This includes cash, credit, money market and mutual funds. Monetary and fiscal policies are both used to influence the economy; key differences exist in these 2 policies, fiscal decisions are set by the national government while monetary policies are implemented by the central bank. Monetary policy has less decision and operational lag compared to fiscal policy which has to go through congress, and the impact is slower as people take a longer time to react to income adjustments. Monetary policies affect all sectors of the economy with variability in impact whereas fiscal policy can be targeted to affect specific groups.
A recessionary gap occurs when actual output and fiscal policy can be used to close the gap. It is further defined as the difference between potential and actual output. Excess unemployment is a characteristic of the economy in a recession. The deep recession can be traced to the crisis brought about by the collapse in the housing sector which led to financial crisis and collapse of production and consequently employment plummeted. Approximately 9 million jobs were lost in the recession (Samuelson, 112).
The Federal Reserve came up with aggressive measures to respond to the crisis through the employment of various tools to respond to the recession. These tools were put in place in 2007 and 2008 and included lowering of the fund from 5% to zero with the aim increasing liquidity and credit flow (Stark, 2). Later the Federal Reserve lowered the long term interest rates by purchasing mortgaged backed securities, treasury securities, and agency debts from the government worth $1.7 trillion with the aim of stimulating economic growth and reducing the risk low inflation.
The current economic situation in the United States is that the economy is gradually recovering from the recession and is slow but steadily entering the growth phase. Employment rates have picked up although it might take another 3-4 years before it goes back to its long term sustainable level, consumer spending has greatly increased contrary to forecasts, exports, and manufacturing and business investments have experienced tremendous growth.
Having implemented the above combination of fiscal and monetary policies, the United States economy is expected to expand at a moderate rate perhaps higher than the projected 3% per annum which many critics have viewed as being modest. It is worth noting that this expansion may be affected by various factors such as the increase in energy and commodity prices which effectively taxes consumers, consequently reducing their purchasing power and this translates to slow GDP growth. However history shows that increases in energy prices tends to decrease and therefore the economy retains its stability.
These policies also imply that inflation will be contained, as the economy recovers the rate of wage growth is slow, which contributes to the determination of the cost of producing goods and services. Another factor which indicates that inflation will be kept in check is the disinclination of retailers to raise their prices in the face of strong competition.
Conclusion
These are challenging times for the United States economy. The Federal Reserve can only chart the way forward for the US economy and consider potential risks that might cause an imbalance and be prepared to respond to them accordingly.
Works cited
Samuelson P., Nordhaus W. Economics. New York Mc Graw- Hill 2006.
Stark, Jurgen. The economic crisis and the response of fiscal and monetary policy. 2009
Retrieved from http://www.ecb.int/press/key/date/2009/html/sp090608.en.html
