Like the Economics for Dummies states, anti-recessionary economic policies come in two flavors: Fiscal Policy and Monetary Policy. Monetary policys technique is to increase the money supply and lowers interest rates. When interest rates are lowered, more people are about to access loans, buy houses, and increase purchasing power. Fiscal Policy involves lowering taxes and increasing government spending so that the economy will have more after tax money.
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Expansionary and contractionary are two types of fiscal policy. Expansionary policy involves raising government expenditures and lowering taxes so the government budget deficit can grow or the surplus to fall. In 2011, Japan suffered from a natural disaster. The north east area of the country was struck by a tsunami causing their country to endure financial issues. Japan used expansionary fiscal policy to help get them out of that terrible economic situation. Expansionary fiscal policy helped Japan by raising their private consumption growth. Contractionary fiscal policy is the opposite of expansionary policy. Government expenditures will be decreased and taxes will be raised to help the budget deficit or surplus.
The Role of Government Budgeting
One of the main tools of fiscal policy is the federal budget. Aggregate demand is affected by the government expenditures and taxes affect investing and consuming. The effects of government expenditure and tax revenues are important in the aggregate demand equation because they can cause AD increase or decrease. “Government expenditures include transfer payments, purchases of goods and services, and interest payments on government debt” Swanenberg. Tax revenues are brought in from social security, indirect taxes, income tax, and corporate taxes. When the amount of taxes brought in is above expenditure expectations, this will factor to a budget surplus.
Fiscal Policy Pros and Cons
Fiscal policy is the usage of government spending and the use of taxes to control the economy. As defined by Investopedia, “fiscal policy is the means by which a government adjusts its level of spending in order to monitor and influence a nation’s money supply,” (2009). Whenever the government makes a decision on what service and good to buy, how much to tax on said good or service, or the payment relegations dispersed, the government is exercising the fiscal policy. The fiscal policy is mostly used to show how government spending and taxation affects the aggregate economy levels. The fiscal policy really was not used as much until after World War II. “When there is a surplus in the government budget, (revenue is higher than spending), the fiscal policy is a contradiction whereas when there is a deficit in the budget, (spending is higher than the budget), the fiscal policy is defined as being expansionary,” as stated by the Library of Economics and Liberties (Weil 2008). The Library of Economics and Liberties also states, “when there is a deficit in the fiscal policy, economists focus more on the difference in the deficit and not the levels of the deficit,” (Weil 2008).
The fiscal policy however is not perfect. Just like everything in nature, the fiscal policy has its strengths and weakness. According to Dr. Wood, one main strength about the fiscal policy is that since it is basically government ran, “it has good stability when used properly in the economy” (Wood 2009). Contrary to monetary policy, the fiscal policy focuses on one area instead of the economy as a whole which can result in less mistakes and less headaches. Government interaction aids the fiscal policy by helping with resource allocation.
As mentioned before, the fiscal policy is not perfect. Because the fiscal policy deals with the government, there may be little to no room for flexibility, (Wood 2009). An example would be, the government can’t decide to raise taxes to compensate government spending. David Weil has stated that, “fiscal policy also changes the burden of future taxes,” (Weil 2008). The fiscal policy can sometimes result in the “domino effect,” meaning having one problem can cause more problems, which can result in another problem, and so on. The fiscal policy is usually only implemented once a year so this itself can be a weakness. One reason is because the government may be funding a project, such as a highway being built, and may not be finished in the allotted time, thus causing a problem in government spending. As of October 2012, Forbes has elucidated that the fiscal policy is not as effective as it once was by stating, “the Central Bank can’t lower its interest rates,” (Smith 2012). Smith also goes on to state that, “if the government steps in and borrows lots of money then the rate of interest will tend to rise,” (Smith 2012).
After the Great Depression, market economies learned that they were not adjusting to economic downturns quickly enough. The lack of response was one of the causes of long-lasting economic crises. Therefore the government started to stick its hand in the economy to keep it from spiraling out of control using fiscal policy. When GDP contracts, the government spends more, and taxes less, which gets the economy growing. Another form of government macroeconomics is monetary policy and it is practiced by the Federal Reserve Bank. The Fed fiddles with the money supply to keep the economy in between inflation and recession.
Back in the 1960’s President Johnson had to increase government spending due to the Vietnam War. Economists believed as the President kept spending money, it would lead to inflation. The inflation would be caused by an economy that is already stable, plus increased government spending, which only creates higher prices and aggregate supply will be limited. The Federal Reserve Bank and monetary policy was then instituted. Its job is to make the necessary corrections in the economy that the government will not make. The Fed is a private sector.
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The Federal Reserve Bank affects the economy’s rate of interest. Our central bank increases the amount of money circulating in the economy because the higher quantity of something decreases its price. With a lower price of money, also called a lower interest rate, more people will be willing to borrow money, which means they spend more money in turn giving the economy a boost. The only problem is some economists believe it will cause prices to spike quickly. So out of fear of inflation, the Fed decreases the amount of money circulating in the economy which raises the price of money, or raises the interest rate. Higher interest rates mean less borrowing, which means less spending, which slows the economy down. Now the fear is the economy will fall into a recession so the Fed lowers interest rates again.
The Fed raises the interest rate out of fear of inflation which then causes Recession. The Fed lowers the interest rate out of fear of recession which then leads to inflation. The Fed controls the money supply, which increases or decreases interest rates that can potentially boost or slow an economy and the Fed must keep a good balance because one direction is recession and the other is inflation.
Overall monetary policy plays a big part in our economy, without it there would be a lot of confusion in the business world. In particular, the main one would be the banking system. The Federal Open Market Committee (FOMC) is the body that’s responsible for most of the monetary policy decisions that are made. Monetary Policy has to do with recession and inflation which is very important in our economy. Another important fact about monetary policy is aggregate supply and demand. Monetary policy affects them deeply depending on the economies input, output, and rate of inflation.
Strengths and Weakness of Monetary
Furthermore, monetary policy that is speedy and flexible and somewhat isolated from Political pressure. It doesn’t raise inflation value of money by weaken its purchasing Power. Whenever inflation advance faster than expected, they may sell government bonds to take money out of circulation. This also can minimize access to credit and slow consumer spending. The decisions they had made really had an effective impact on our economy. Monetary policy has stable prices which is keeping inflation low, it also quality business and households to make financial decisions without worrying about sudden unexpected prices increasing. The long term enable policy makers assess. The best policy tends to seek between these short- and long- term goals. Lower interest rates to expand the money supply and stem rising unemployment Rates during recession. Although the weaknesses practicing monetary policy cause the central bank to lose control of currency valuation, it wouldn’t be possible for interest rates. It also devalues the currency; further more monetary policy can achieve low inflation in the long run and affect economic output and employment in the short run. Sustainable Low inflation and economic growth off disagree. When inflationary pressures decrease, the unemployment rate may advance for a short period as the pace of the economy slows. It also can take up to months or even an year maybe even longer to have the intected effect.
Monetary and Fiscal policy both have their pros and cons. Fiscal policy can result in a nasty domino effect causing one problem to make another and repeat. Fiscal can also have issues with time lags. Although monetary policy is not very effective in a recession, it is flexible and works well to slow down the economy. Many prefer fiscal over monetary because its brings low taxes and low interest rates.