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Monetary and Fiscal Policy
The Monetary and Fiscal Policies, although controlled by two
different organizations, are the ways that our economy is kept under
control. Both policies have their strengths and weaknesses, some
situations favoring use of both policies, but most of the time, only
one is necessary.
The monetary policy is the act of regulating the money supply
by the Federal Reserve Board of Governors, currently headed by Alan
Greenspan. One of the main responsibilities of the Federal Reserve
System is to regulate the money supply so as to keep production,
prices, and employment stable. The “Fed” has three tools to
manipulate the money supply. They are the reserve requirement, open
market operations, and the discount rate.
The most powerful tool available is the reserve requirement.
The reserve requirement is the percentage of money that the bank is
not allowed to loan out. If it is lowered, banks are required to
keep less money, and so more money is put out into circulation
(theoretically). If it is raised, then banks may have to
collect on some loans to meet the new reserve requirement.
The tool known as open market operations influences money and
credit operations by buying and selling of government securities on
the open market. This is used to control overall money supply. If
the Fed believes there is not enough money in circulation, then
they will buy the securities from member banks. If the Fed believes
there is too much money in the economy, they will sell the
securities back to the banks. Because it is easier to make gradual
changes in the supply of money, open market operations are use
more regularly than monetary policy.
When member banks want to raise money, they can borrow from
Federal Reserve Banks. Just like other loans, there is an interest
rate, or a discount rate, the third tool of the monetary policy. If
the discount rate is high, then fewer banks will be inclined to
borrow, and if it is low, more banks will (theoretically) borrow
from the reserve banks. The discount rate is not used as frequently
as it was in the past, but it does serve as an indicator to
private bankers of the intentions of the Fed to constrict or
enlarge the money supply.
The monetary policy is a good way to influence the money
supply, but it does have its weaknesses. One weakness is that tight
money policy works better that loose money policy. Tight money works
on bringing money in to stop circulation, but for loose policy to
really work, people have to want loans and want to spend money.
Another problem is monetary velocity. The number of times per
year a dollar changes hands for goods and services is completely
independent of the money supply, and can sometimes contradict the
efforts of the Fed. The benefits of the monetary system are that
it can be enacted immediately with quick results. There are no
delays from congress. Second, the Fed uses partisan politics,
and so has no ties to any political party, but acts in the best
interests of the U.S. Economy. The second way to influence the
money supply lies in the hands of the government with the
Fiscal Policy. The fiscal policy consists of two main tools. The
changing of tax rates, and changing government spending. The main
point of fiscal policy is to keep the surplus/deficit
swings in the economy to a minimum by reducing inflation and
recession.
A change in tax rates is usually implemented when inflation is
unusually high, and there is a recession with high unemployment. With
high inflation, taxes are increased so people have less to spend,
thus reducing demand and inflation. During a recession with high
unemployment, taxes are lowered to give more people money to
spend and thus increasing demand for goods and services, and the
economy begins to revive.
A change in government spending has a stronger effect on the
economy than a change in tax rates. When the government decides to
fight a recession it can spend a large amount of money on goods and
services, all of which is released into the economy.
Despite the effectiveness of the Fiscal policy, it does have
drawbacks. The major problems are timing and politics. It is hard
to predict inflation and recession, and it can be a long period of
time before the situation is even recognized. Because a tax cut
can take a year to really take effect, the economy could revive
from the recession and the new unnecessary tax cut could
cause inflation. Politics are another problem. Unlike the
monetary policy run by the partisan Fed, the fiscal policy
is initiated by the government, and so politics play a key role in
the policy. When the concerns of the government are viewed, it
becomes obvious that a balanced budget is not the primary
objective, anyway. The fiscal policy can also be used as a
campaign tactic. If tax cuts are initiated and government
spending is increased, then the president is more likely to be
re-elected, but has first to deal with the inflation his tactic
caused.
Monetary and fiscal policies are what helps keep the nation’s
economy stable. With them it is possible to control demand for
services and goods and the ability to pay for them. It is possible
to manipulate the money in private hands without directly affecting
them. The policies are simply a myriad of tools used to prevent
a long period where there is high unemployment, inflation, and
prices, along with low wages and investment.
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