Following the American Psychological Association’s Guidelines
INTRODUCTION
The economy management of the country has two kinds of policies to intervene and regulate the markets in case of market failure: Fiscal policies and Monetary policies. Fiscal policies are the responsibility of the government, and the monetary policies are implemented by the Federal Reserve System (FED). The economic policies can be implemented in two ways: expansionary and contractionary economic policies. Expansionary policies stimulate the economy and expenditures of consumption and investment increases as the result of these policies. Contractionary policies slowdown the economy, and the expenditure level decreases. In this essay, the definitions of the fiscal and the monetary policies and the mechanism that these policies influence the markets and the economy are to be discussed. Specifically, expansionary economic policies will be discussed.
EXPANSIONARY FISCAL POLICY
Fiscal policies are the policies implemented by the government by changing settings of taxation and government spending. Fiscal policies indirectly influence the economies through changing individuals’ spending. There are two kinds of fiscal policy implementation: Expansionary fiscal policies and contractionary fiscal policies. As known, the capitalistic markets are government-intervention-free markets, and only if the markets become unsustainable due to the economic crisis, the government intervenes. In another word, the government monitors the markets and in case of market failure; it is the government’s duty to fix this failure. Considering the economic policies in terms of fixing the economy, the expansionary policies are required to stimulate the economy after the economic crisis slowing down the economy.
Expansionary fiscal policy means that increasing the opportunity of spending at a higher level in the economy and to enable people to spend; the government might (1) decrease the tax ratios or (2) increase the government spending.
Taxes are called government savings and in another word, taxation is a way of redistributing the income among the agents in the economy. The government makes the decision of collecting the taxes from some sectors in the economy, and the taxes are used to finance the government spending. Therefore, by selecting the sectors to collect tax from in the economy influences the income distribution in the economy. For example, if the government would like to develop the high technology products sector in the economy, the taxes on the producers of the high tech producers is pulled down, and some incentives are created for this sector. By providing these advantageous to this sector, the agents in the sector can produce at a low level of production costs; therefore, they can develop themselves, in another word, instead of paying taxes, they invest in developing their businesses. If the government wants a sector to go down, the government places higher taxes on this industry. For instance, cigarettes and alcoholic beverages are harmful to the individuals’ health, and it causes very high costs of health. Thus, many governments place very high taxes on tobacco products and alcoholic beverages. A fiscal policy might aim at increasing a social groups spending. If the government wants high level of investments, the taxes on the expenditures related to making a new investment can be decreased.
The fiscal policies do not influence the markets and the economy directly. The government changes the settings of taxation and government spending; however, if people do not follow what the government suggests, then the fiscal policy might not create the desired influence on the economy. For instance, increasing the taxes on the tobacco products to decrease the health costs occurring due to the use of tobacco products might not work if people are truly addicted to the cigaret. In some less developed countries, we observe that people are protesting the tax increases on some addiction creating products and the price increase because of the tax increase is not decreasing the number of people smoking. Another example can be an expansionary policy aiming at increasing the investments in the economy. Let us assume the government has created some incentives and decreased the taxes on the investment related expenditures. If the investors believe that the economic conditions are suitable for new investments, then the expansionary policy might stimulate the economy, and increase the investments. However, if the investors loses their trust against the economy or the government policies, then the policies might not be able to stimulate the economy.
Consequently, the responses of the agents in the economy against the government polices are an important determiner in the economy. Implementing an expansionary fiscal policy has to be done parallel to a stakeholder management policy by the government. Managing the reactions against the fiscal policies is an important part of the implementation of the fiscal policy.
Assuming that the government trustable and the economic conditions favor the implemented fiscal policies, normally we expect that the expansionary fiscal policies increase the aggregate demand in the economy. The low level of taxes or the high level of government spending in the economy means high level resources available for the investors and the other agents in the economy. When the taxes are low, then we can buy more things in the market,
and if the government spending is high then we can receive some extra income from the government. As we know, when the government spends, the resources collected by the government are given to the private sector or people. Subsequently, the agents who are willing to increase expenditures of investment or consumption will have some extra resources, or in another word, the resources will be transferred from the public sector to the private sector, and the demand for the consumption and the investment goods will be increased.
The fiscal policies, under the suitable economic conditions, might cause an increase in the aggregate demand. The increase in the aggregate demand will increase the demand for many goods and services in the economy and the economy will start producing more from these goods relatively. Thus, the expansionary fiscal policies will stimulate the economy. In a circle, every extra spending will increase the income and increase the spending more. Eventually, an expansionary fiscal policy by decreasing the taxes or increasing the government spending will increase the aggregate demand and the economy will produce more. The producers will make higher profits relatively, and the gross domestic production will increase. The high profits for business and the high production thanks to the fiscal policy will increase the employment in the economy.
Expansionary Monetary Policies
Monetary policies are essential managing the economic development and the economic growth. As we know that the monetary values are important indicators for every person in the economy. For example, money supply, interest rates, exchange rates, supply of bank money, and many other monetary variables are observed by the people. These variables directly influence the agents’ decisions about making new investments or increasing their consumptions. Decrease in the interest rates allows people to get loans at low cost level. When money supply is increased, the interest rates go down, and we can observe the results immediately in the markets. When the national currency loses value against the other national currencies, then the imported products become cheaper inside the country. If the imported products are normal goods, the demand for them increases. Subsequently, the examples show us that the changes in the monetary variables change our decisions immediately.
There are a few monetary variables that economy management can change or influence: interest rates, exchange rates or money supply. However, controlling two variables at the same time by the economy management is not possible because of the interactions among the monetary variables. For instance, decreasing the money supply and it will cause an increase in the interest rates or vice versa. Consequently, the economy management can use only one tool while implementing the monetary policy.
The monetary policies are implemented by the FED. The FED has three main objectives: protecting the national currency against the other national currencies, providing a monetary stability for the economy without a high inflation, and helping the government keep the employment level high. The FED might create an expansionary monetary policy or a contractionary monetary policy. Expansionary monetary policy is mostly used to help the government increase the employment and stimulate the economy.
The monetary policies provide immediate results comparative to the fiscal policies because the monetary policies changes the some economic variables monitored by the people and it is easier for people to do something in the money markets. However, there exists a risk for the monetary policies similar to the fiscal policies; if the agents in the money markets do not trust the economy management and if the economic conditions are not suitable, then monetary policy might not reach its objectives. For instance, let us assume that the FED loses its credibility in the market, and the FED is targeting the interest rates to stimulate the economy. To be able to do this, the FED has to decrease the interest rates. Let us assume that the FED could be able to decrease the interest rates; however, in spite of the low interest rates, the investors might not increase their investments, or the people might not increase their consumption. Because the investors or the customers might be expecting that the interest rates will increase in the close future due to the undesired economic conditions in the market. Consequently, the monetary policies’ effects on the economy are more immediate relative to the fiscal policies; however, the trust and the suitable economic conditions determine the success of the implemented monetary policies.
The FED uses three main tools to implement the monetary policies: 1) required reserve ratio, 2) discount rate, and 3) open market operations. I will explain each tool below:
1- Required reserve ration:
Every financial institution has to place some of its reserves into the FED system, and this is regulated by the law. The FED might use the required reserve ration to control the money quantity in the market. When the required reserve ratio is decreased, then the financial institutions have to place less financial resource into the FED system; therefore, they can produce a higher amount of bank money. Producing a higher amount of bank money means a high level of the money supply and the interest rate goes down. Consequently, a decrease in the required reserve ration causes an expansion in the economy. Increasing the required reserve ratio works the same mechanism explained above, and it causes a slowdown in the economy. Required reserve ratio tool influences the financial situation directly, and it influences the money markets indirectly. It is an easy tool to use for the FED because only a simple official letter is required to be sent to the financial institutions, and the financial institution has to do what they are asked by the FED.
2- Discount rate:
The FED is called as the bank of all the banks. Because the FED is the strongest institution in the money markets thanks to the right of printing money that is given to the FED officially. Therefore, when the financial institution needs some liquidity, they go to the FED to get the liquid resources they need. They have some bonds and they sell them to the FED to get some liquidity; however, the FED does not pay the nominal value of these bonds and apply a discount from the nominal value of these bonds because there is some time to get the money written on the bond, and the FED has to wait this deadline to receive the money. The discount ratio applied to these bonds are called discount ratio.
When the discount ratio is smaller, then it is less costly for the financial institutions to get financial resources from the FED. Because of that, the lower discount rates cause an expansion in the economy. When the banks get liquidity with low costs, they can produce a high amount of bank money and the people can find better credit opportunities. If the discount rates are high, then it becomes costly for the financial institutions to get resources from the FED.
3. Open market operations:
Open market operation is a tool for the FED to control the money supply. When the FED wants to increase the money supply, the FED buys the government bond papers from the people and gives the money to the markets. When the FED wants to decrease the money supply, the FED sells the government bonds and collects the money from the markets. Consequently, buying the government bonds causes an expansion in the economy, and selling the government bonds causes a slowdown in the economy.
Consequently, the monetary policy tools can be used to stimulate or slowdown the economy. The expansionary policies causes a high level of consumption and investment in the economy, and the gross domestic product increases. The increase in the GDP causes an increase in the employment.
REFERENCES
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Taylor, John B.. "The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong." Stanford University Working Paper (2008): 1-19. 8 Mar. 2014 <http://www.stanford.edu/~johntayl/FCPR.pdf>.
Stiglitz, J. E. and Walsh, C. E. (2007). Economics, W.W. Norton & Company, Inc.,
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