In modern economy monetary and fiscal policies are the key elements of government regulation. Expansive monetary and fiscal policies often lead to budget deficit and national debt increase. The main goal of this paper is to reveal how monetary and fiscal tools can stimulate the economic growth and prevent negative effects such as inflation.
FISCAL AND MONETARY INSTRUMENTS OF ECONOMIC GROWTH AND INFLATION CONTAINMENT
When real GDP is below the nominal, it means the economy is facing the money devaluation process, or inflation. The Federal Reserve System anticipations of the main macroeconomic indicators have revealed the relatively stable growth of the economy. The U.S. economy average inflation rate is 1.7 percent through the annual period ended October 31, 2014. The main tools of monetary policy that can stimulate the growth of economy are lowering the interest rates and changing the money supply by trading government securities or implementing new requirements for bank reserves.
The 2008 financial collapse has lead to short-term interest rates reduction to almost zero value. They remain extremely low until now. In perspective of economical growth the rates should be fixed at low level. Thus entrepreneurs can afford loans that can stimulate production expansion. Households will have access to cheap consumption credits. These factors should boost the aggregate demand and supply. The money supply can be gradually increased to support the increasing level of transactions. Basically, primary goal is to raise monetary base proportionally with the level of production in order to avoid the uncontrolled inflation.
The government can also trade public securities. The purchase of public securities by the government lowers the interest rates. In terms of economic stimulation of 2008-2014 the Federal Reserve System has been purchasing not only treasury bills, but also other financial instruments. This policy was named quantitative easing (QE) and was aimed to reduce the long-term interest rates and thus give boost to the economy. Moreover, the large-scaled purchase of securities has increased the money supply and improved the liquidity in banking sector (Christensen, 24). The Treasury can also sell the public securities. Mostly this happens when the government needs to cover budget deficit. This also contains the inflation rate as sale of government financial assets reduces money supply and provokes the increase of interest rates.
The QE program has significantly increased bank reserves due to the unexpected money supply. The Fed can also introduce the requirements to banking sector to lower the reserves in order to increase money supply. However, insufficient reserves carry risks for banking system reliability. The increase of bank reserves, on the contrary, leads to reduction of money multiplication ability; it also can control the inflation level.
The fiscal policy has significant impact on economic growth by encouraging the aggregate demand. The main instruments of fiscal policy are taxation and government spending. The level of personal taxes is always reduced when it comes to stimulating consumption. Lower corporate tax rates can encourage companies to invest into business expansion or to cancel loans.
Historically government spending is growing in the recession cycle of the economy. The government programs include financing of priority industries, creating workplaces and different social initiatives. The main goals of fiscal tools are to boost the demand and to strengthen public confidence. Large government expenditures usually lead to significant increase in budget deficit.
FISCAL AND MONETARY TIME LAGS
Both fiscal and monetary policies encounter time lags. The fiscal policy time lags related to government spending can reach up to several decades. The longest lags are observed in government spending programs such as education program or space program. The time between the start of education program and the benefit, that graduated specialist brings to the economy, can be more than five years. Besides, when the economic benefit is deferred in time, it is hard to measure the expedience of the government program and its relevance when it begins to influence the economy. The same refers to taxation. The savings from tax ease have to be accumulated at first in order to have an impact on the market.
Besides, both government spending and taxation have legislative lag – the time between the proposal of initiative and its legal implementation. Financial crisis of 2008 was also a crisis of confidence when business units and households didn’t anticipate positive changes in future and preferred to save money rather than to spend them.
The monetary policy is less exposed to time lags. The decrease of interest rates and additional money supply are easier to achieve in short terms. However, the economic effect of these measures is also based on people’s confidence and economic anticipations. The less positive future expectations are the more time it takes the economy to react on government’s monetary decisions.
U.S. FEDERAL DEFICIT AND NATIONAL DEBT
The main drawback of government regulation through fiscal and monetary instruments is that the government spends money faster than it can collect respective revenues. The federal deficit is the negative difference between federal budget revenues and expenditures. The U.S. national debt represents the total amount owed by government through the issue of financial instruments. Constant budget deficit leads to government debt.
During the recession cycle the gap between the government revenues and outlays growth rapidly. The significant drop in income is caused by decreased level of production, low aggregate demand and overall business activity downfall. This affects the key source of government receipt – taxation. The government trying to stimulate the demand lowers tax rates which also reduces revenues. Meanwhile, the government expenditures rise for the reasons discussed above. According to Chantrill the federal deficit has risen up to almost $1,500 billion in 2009 fiscal year while in 2014 the deficit was cut back to almost $500 billion.
The national debt has increased up to 18 trillion or 111 percent of GDP. The rate, higher than 60 percent of GDP, is considered to be critical for the economy, as it makes the debt servicing too expensive. After the 2008 world financial crisis most economies have suffered huge national debt growth. The national debt of Japan has soared up to 250 percent of GDP; most EU countries like Italy, Germany and France maintain the national debt on 80-100 percent level. The main argument is that the global public debt is constantly rising and not a single country has found an offset solution.
Works sited
"Sections of Part 3." FRB: Part 3: Summary of Economic Projections. 14 Mar. 2014. Web. 2 Dec. 2014. <http://www.federalreserve.gov/monetarypolicy/mpr_20140211_part3.htm>.
Christensen, Jens H. E., and James M. Gillan. "Does Quantitative Easing Affect Market Liquidity?" Federal Reserve Bank of San Francisco (Federal Reserve Bank of San Francisco). 1 July 2014. Web. 2 Dec. 2014. <http://www.frbsf.org/economic-research/files/wp2013-26.pdf>.
Chantrill, Christopher. "Recent US Federal Deficit Numbers." US Federal Deficit Definition. Web. 2 Dec. 2014. <http://www.usgovernmentdebt.us/federal_deficit>.
