Stimulative Monetary And Fiscal Policies example essay topic

Fiscal Policy vs. Monetary Policy With America in recovery from the attacks on our freedom and our economy, many wonder if we will return to phase one (expansion) and how long it will take to reach phase two (recession) again. The Keynesian Theorists of America believe that the government should actively pursue Monetary policies (enacted by the Federal Reserve Bank) and Fiscal policies (enacted by Congress) to reach adjustments to price, employment, and growth levels. In our full market economy, we must use these economic policies to control aggregate demand. When these policies are used to stimulate the economy during a recession, it is said that the government is pursuing expansionary economic policies. Fiscal Policy is described as changing the taxing and spending of the federal government for purposes of expanding or contracting the level of aggregate demand; these are designed to increase short-run economic growth. In a recession, an expansionary fiscal policy involves lowering taxes and increasing government spending.

By cutting taxes, increasing government spending programs, and increasing transfer payments, more money is in the economy, more income, and more spending. This can be done through the federal budget process; however, the problem with fiscal policy is lag time. This process can take so long (as long as a year or more) that Discretionary Fiscal Policy is very rarely used in the federal government; still, the lag between a change in fiscal policy and its effect on output tends to be shorter than the lag for monetary policy. Instead, the government uses Non discretionary Fiscal Policy (Automatic Stabilizers).

This fiscal policy is built into the structure of federal taxes and spending. Some examples of this are the progressive income tax (the major source of federal revenue) and the welfare systems, which both act to increase AD in recessions. Monetary policy is under the control of the Federal Reserve System and is completely discretionary. It is the changes in interest rates and money supply to expand or contract aggregate demand. In a recession, the Fed will lower interest rates and increase the money supply. The Federal Reserve System's control over the money supply is the key Mechanism of monetary policy.

They use 3 monetary policy tools- Reserve Requirements, Discount Rates / Interest Rates, and Open Market Operations. The reserve requirement is the percentage of bank deposits a bank must hold in reserves and cannot loan out. By raising or lowering the reserve requirements, the Fed controls the amount of loanable funds. The interest rate is the amount the FED charges private banks, so they can meet the reserve requirements. The prime rate is currently set at 5%. If the Interest rate is low, the banks will borrow more money from the FED and the money supply will increase.

Interest rates have been above average for the past 20 years, but are currently considered low. Open Market Operations is the most effective and most used daily. An OMO is the Fed's purchase or selling of bonds. When the Fed buys bonds on the OMO money is deposited into banks; this gives banks excess reserves to loan, which increases the money supply. By decreasing reserve requirements and interest rates, and by buying securities through the OMO, it is an expansionary tool; money supply is increased, interest rates decrease, which causes crowding in and increases investment. The Federal Open Market Committee (FOMC), which meets every 6-7 weeks, makes these decisions.

The changes in these policies can be done immediately, although impact on AD can take several months. Monetary policy has become the major form of discretionary contra cyclical policy used by the federal government. The major source of conflict is that the Fed is independent and not under the direct control of either the president or congress. Both stimulative monetary and fiscal policies are expected to stimulate economic growth.

While both of America's economic policies are different, both are used to influence the performance of the economy in the short run. Bradly R. Schiller. "The Economy Today". 2000, McGraw Hill Higher Education. 8th editionInvestorWords. com web Reserve Boards. html USA Gold. com web.