1. Monetary Policy
Monetary policy is a strategy related to the flow of money in the economy and its value. It also shows the association between rate of interests in the economy and the total supply of money and exchange rates. It is also a demand side policy which the government can use to accomplish its macroeconomic goals; that is, maintain economic growth, low rate of inflation, low unemployment and stability of payments equilibrium. Moreover, monetary policy is known as accommodative, if the interest rate laid down by the central monetary power is planned to create economic growth; neutral, if it is planned neither to generate growth nor fight inflation; or tight if planned to decrease inflation.
“The monetary policy has two basic goals: To promote maximum sustainable output and employment, and to promote stable prices.” These goals are prescribed in a 1977 amendment of the Federal Reserve Act. (Federal Reserve Bank of San Francisco)
The central banks of any country (Federal Reserve (Fed) in the case of U.S.) are responsible to set up the monetary policy in a way that is best for the economic growth of a country. The Fed modifies monetary policy to encourage highest sustainable expansion in output and unemployment and to keep inflation low and steady. To do so it lowers interest rates which result an increase of aggregate demand due to which more consumption of goods through credit, more investments by firms will take place, resulting in depreciation of exchange rates which leads to more exports and fewer imports as they become costly and resulting in an increase in jobs. Hence more money comes into the economy and less money leaves so the economy grows. The chartered banks in this situation use additional balances and purchase government bonds and treasury bills being sold by the Fed. The increased demand of these assets increases the prices and the yield falls. If the banks wish to achieve the alternative they would do the reveres, that is transfer deposits from the chartered banks to the central banks. The selling and purchasing of the government securities and bonds by the central bank of a country is known as “Open Market Operations”, which is a tool of monetary policy.
Monetary policy can be contractionary, slowing the economy, or expansionary stimulating the economy. The required-reserve ratio is the amount of money the banks are supposed to keep in the banks and cannot lend it out. The amount to be kept in reserve by the bank is set up by the government or Fed. So if the Fed wants to increase the money supply in the economy it will decrease the reserve ratio, hence allowing the bank to lend out more to the people. This becomes expansionary, as there is more money in the market and the spending increases. However, if the Fed increases the reserve ratio the reverse happens and the economy slows down as there is less money available in the market, so this becomes contractionary.
The discount rate is the third tool used by the Fed to stabilize the economy in the U.S. If the Fed increases the interest rates at which the chartered banks can borrow money from it, then the banks are less likely to take loans hence it slows down the economy. However, if the Fed decreases the interest rates then the banks are more likely to borrow money for circulating in the market and expanding the economy. However the banks do not always go to the Fed, but rather go to other banks so as to save their privilege of borrowing at a better time and saving the banks from audit by the Fed as considered as mismanaged.
The Fed prefers to use the OMO (Open Market Operation) more instead of the other tools because, it’s quick and easy due to online transactions, and also flexible and reversible.
2. Fiscal Policy
Fiscal Policy can be defined as revenue collected by the government through different sources; and the expenditure the government needs to make in order to bring economic growth in the country. According to Keynes, it is important to get the economy out of recession hence it is very necessary for the government to have a well planned fiscal policy.
Fiscal policy is the change in government income and expenditure which influences the aggregate demand. This policy is made by the government with a goal of full employment, taxation, government spending, price stability, economic growth and development.
The main objective of fiscal policy is the development of the country. Utilization of revenue must be targeted with a balanced expenditure. The government must have enough budgets to create employment opportunities to bring development in the country. Controlling inequality in the rates of per capita income should be the responsibility of the government.
The main purpose of the policy is to reduce inflation and to stimulate economic growth when there is recession and aim to stabilize developments in the country.
The major tool to organize a well planned policy is fixing the rate of taxation. This is the main source of earning for the government. Hence higher rate of taxation would adverse economic development whereas decreased rate would encourage purchasing. This will enhance income and investment. Therefore, the government needs to plan a progressive taxation policy.
Another tool for making a fiscal policy is a balanced expenditure plan. Priority should be given to which ever sector funding is necessary. Expenses can be increased or decreased as per requirement. If expenditure exceeds sources of income then the deficit can be met by issuing currency notes by the Fed. This would bring inflation in the country, which would be a deficit financing policy.
3. Fiscal Vs Monetary Policy to grow U.S. Economy
The government should decrease aggregate demand by cutting down expenses and increase tax. This will reduce spending bringing improvement in budget deficit. To dampen economic activity we ought to control inflation. For this we could implement a surplus budget by implying increased taxation and a reduction in borrowing. A well balanced fiscal policy increases employment by cutting down taxes and increasing government expenses. This would increase aggregate demand and there could be chances of creating jobs.
The use of monetary policy can help the economy stabilize as the Fed can reduce interest rates thus promoting more spending, investments and borrowing. Moreover, the increase in exports and reduction in imports will bring economic growth and stability in the country. This would result in more circulation of money and reduce inflation and recession.
The use of both these policies can help in improving the economic conditions of the U.S. As fiscal policy can help to increase employment and monetary policy can help reduce inflation and increase the money circulation within the U.S. economy.
Works Cited
U.S. Monetary Policy: An Introduction. Federal Reserve Bank of San Francisco. 2011. Web. 15 April 2012.
Wikipedia contributors. "Fiscal policy." Wikipedia, The Free Encyclopedia. Wikipedia, The Free Encyclopedia, 16 Apr. 2012. Web. 18 Apr. 2012.
n.p. Fiscal vs. Monetary Policy. U.S Department of State. n.d. Web. 15 April 2012.
Jones, Bryn. “Monetary Policy”. Bryn Jones Online. 19 October 2009.
< http://www.youtube.com/watch?v=kQnAmjo1RYw >
Rabbior, Gary. Monetary Policy: An Overview. Money and Monetary Policy in Canada. The Canadian Foundation for Economic Education. 124-144. Web. 14 April 2012.
< http://www.cfee.org/en/pdf/moneymonetarypolicy_ch8.pdf >
