Support For Monetary Policy example essay topic

The United States government has many jobs and responsibilities that they must deal with every day. The role of the government in the American economy reaches well beyond regulating industries. They perform other tasks, such as; printing money, creating an operating budget, and most importantly, managing the overall pace of the economy, while trying to keep high levels of employment and stable prices. The government has many options available in dealing with the problems of a fluctuating economy, which are broken into the two main tools of fiscal policy and monetary policy.

In 1936 John Maynard Keynes wrote The General Theory of Employment, Interest, and Money. In the book he states that people did not have enough income to buy everything the economy could produce which caused prices to fall and companies to loose money. Keynes feared that without government intervention a degenerating downward spiral would be created. He suggested that the government increase spending or cut taxes to increase the incomes of the public. Although he knew these tactics would mean that the government would have to run up a deficit; ultimately he felt that if nothing was done the outcome would be much. Support for his ideas grew; especially when military spending increased during World War II and people saw his predictions come true.

All of a sudden incomes increased, demand rose, and factories operated at full capacity again. Although it worked perfectly in the 1940's, the problems were not realized until the late 1960's when President Lyndon B. Johnson along with congress decided to cut taxes and start several new spending programs. Strong consumer spending soon pushed the demand for goods beyond what the economy could produce. Prices began rising, which resulted in increased wages, which in turn caused prices to raise even more creating an endless cycle between the two, which is know as inflation. Keynes also had an answer for dealing with inflation, raise taxes and reduce spending. However, the dilemma with his philosophy is impacted by politics.

All politicians want to be rehired and know that if they vote to raise taxes that they will lose support and probably not get reelected. Fiscal policy is defined in Exploring Economics as the use of government purchases, taxes, and transfer payments to alter equilibrium output and prices. Basically this means that the government will increase or decrease its spending to try to keep the economy running at a steady pace. If the government decides to increase spending they might hire people to build a new road.

These people will now have jobs and a better income therefore increasing overall spending. This leads to increased corporate income enticing them to increase their wages or investments. The same affects can be achieved by lowering taxes. An interesting note is that while a tax cut will carry the same marginal propensity to consume, which is basically the percent of income that people will spend in the economy on goods and services, while a tax rebate will exhibit a much higher percentage. A major concern that economist have with fiscal policy is the lag time. Lag times exists because fiscal policy in order to serve their purpose must follow a few steps.

The lag times themselves are a problem because by the time a policy starts taking effect on the economy, the economy could already be repairing itself. The delay could cause either a deeper recession or more inflation. First all the information must be gathered and analyzed to determine the current condition of the economy. The monetary policy makers and the fiscal policy makers have a large number of economists that make recommendations. If determining the state of the economy was not hard enough they must then predict the future of the economy.

Once a prediction has been made for a recession or boom, a decision must be made on what can be done to alleviate the problem. After the decision is made and the plan has been enacted, the process is still not over. The policy makers must then wait to see if the plan succeeds and hope that it does not take so long that it has a negative effect. However there are a few built-in fiscal stabilizers or automatic stabilizers, which include unemployment insurance and income tax shortages.

Unemployment insurance payments increase during recessions because more people are unemployed. The amount of money received from income taxes will also drop because the average income will fall. In 1913 Congress established the Federal Reserve System in an attempt to strengthen the supervision over banks. Later during the Great Depression Congress gave the Federal Reserve, or the Fed, the authority to vary reserve requirements. The Fed exhibited their influence during World War II when they helped the U.S. Treasury borrow money at low interest rates. Later when the government sold large amounts of Treasury securities to finance the Korean War, the Fed bought heavily to keep the prices of these securities from falling, which increased the money supply.

Since then support for monetary policy has grown. Monetary policies can be enacted much faster so there are no lag time risks and politics do not come into play. When the monetary policy moves toward trying to slow the economy or halt inflation, it does not affect anyone as directly as the fiscal policies would when taxes are increased. The Federal Reserve has three main tools to control the money supply.

The most influential is open market operations, which is the buying and selling of government securities. If the goal is to increase the supply of money then the Fed will buy.