Fiscal and Monetary Policy
Imagine you are listening to the radio around the year 1900 and there is news that the economy is going to enter into a recession. Chances are that sooner or later you will not have a job, and there isn’t going to be nearly as many goods available because of lack of production. The only thing of any value will end up being the money in your checking and savings accounts, so the only choice you have it to run to the bank and get hold of that money. The problem: every other person who just heard that announcement is thinking the same thing, and now there’s going to be a run on the bank, or even worse, a bank panic. This was a serious dilemma prior to the year of 1913 – the year the Federal Reserve Bank was established – because there was no way to ensure the economy would remain stable. Although bank panics were not an everyday thing, it was something that citizens had to worry about more than they do today. When the Federal Reserve Act of 1913 was set in place, however, two policies were enabled to monitor and help control the stability of the economy: to this day they remain a very important part of our government and these courses of action are known as monetary policy and fiscal policy.
To fully understand the purpose of monetary and fiscal policy, it is important to look at the structure behind them. The basis of these policies comes from the Federal Reserve, more commonly known as the “Fed.” The “Fed” is a fairly simple system to understand: it is the central bank of the United States. This central bank is broken down into districts; the Board of Governors being the most recognized, but also included is the Federal Open Market Committee. Today the head chairman of the Board of Governors is Benjamin Bernanke, and he oversees all the actions that are taken.
The Federal Reserve is the only bank with the power to control a run on the banks or a bank panic. It holds the money available to lend to smaller banks as a last resort in bad economic times. Therefore, the Federal Reserve plays a huge part in controlling the money supply of the US. When the “Fed” was established, so was monetary policy. In the book Macroeconomics by R. Glenn Hubbard and Anthony Patrick O’Brien, monetary policy is defined as “the actions the Federal Reserve takes to manage the money supply and interest rates to pursue economic objectives.” These certain objectives include maintaining a stable economy, increasing economic growth, keeping unemployment at a satisfactory low, and keeping prices of goods and services stable in order to minimize the chances of inflation.
The Federal Reserve uses three separate tools of monetary policy to maintain the money supply. These tools include open market operations – controlled by the Federal Open Market Committee – and the discount rate and reserve requirements, which are controlled by the Board of Governors. Open market operations are a tool used by the FOMC to increase the money supply through the buying and selling of Treasury securities. The trading desk at the Federal Reserve Bank in New York is designated to buy these securities and the sellers deposit them into banks. These deposits increase the reserve of the bank which in turn increases the total money supply because there will also be an increase in loans and checking account deposits (Hubbard/O’Brien). The FOMC also has the power to decrease the money supply by reversing the operations of that same process.
The branch of the “Fed” which controls the other two tools of monetary policy is the Board of Governors. One tool, the discount rate, is defined as “the interest rate the Federal Reserve charges on discount loans (Hubbard/O’Brien). If a bank needs to increase the money available in their vault, otherwise known as their reserve, they turn to the “Fed” for the money and this loan is known as a discount loan. However, unless the Federal Reserve has become the last resort in the case of a recession, discount loans are not typically taken out by banks.
In certain instances, such as the case of Black Tuesday when the worst stock market crash hit the United States, discount loans did not save the economy. It was not until after the Great Depression when the run on the banks caused a severe bank panic that Congress established deposit insurance. In other words, prior to the Federal Deposit Insurance Corporation, a person was neither assured that the money they held in the bank was safe nor that they would be able to retrieve it if the economy were to fall into a recession.
The third tool of monetary policy which is also controlled by the Board of Governors to help manage the money supply is reserve requirements. It is a rare occasion for the Fed to change the reserve requirements though. In essence, changing the reserve requirements entails the banks to make “significant alterations in holdings of loans and securities” (Hubbard/O’Brien). Although it is not a common course of action, it is still purposeful. When the Fed decreases the reserve requirements, it allows the banks to use the excess money to loan out as opposed to holding in the vault. Conversely, if the Fed chooses to increase the reserve requirement, the banks will have less money to lend out. Either way, though, the Fed is makes the change based on the assumption that it will help the economy. All of these tools of monetary policy are followed through with the intention of meeting the objectives stated previously. On the other hand, fiscal policy also plays and important role in helping to maintain a stable economy.
Fiscal policy is defined as “the changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives” (Hubbard/O’Brien). Fiscal policy is similar to monetary policy in terms of what it attempts to achieve, but varies because of the way it tries to do so. Changes in taxes and spending are controlled solely through the federal government.
A better understanding of fiscal policy can be explained through the ideas of John Maynard Keynes. His theory came about after the Great Depression and said if the governments were to spend more money in times of economic decline, then it would soon stimulate the economy. He argued that through the excessive government spending, incomes would rise and so would purchases of goods and services. Eventually, this would stabilize the economy and take the country out of decline and into a state of economic growth. His theory was proved when President Franklin D. Roosevelt took action during World War II and spent an excessive amount of money which ending up in economic growth, as Keynes had said it would (What is Fiscal Policy?).
More recently, as of the 1980s, the main goal of fiscal policy has focused on reducing the budget deficit that has skyrocketed since World War II. Because of such things as new technology and foreign trade opportunities economic growth has been happening automatically, and the deficit only continues to rise (What is Fiscal Policy?). The War in Iraq has also caused the deficit to steadily increase, and George W. Bush is currently under pressure to find a way to decrease it. Although the overall goal of fiscal policy is to achieve broad goals of the economy, it now focuses on smaller goals as well.
In conclusion, monetary and fiscal policies are extremely crucial in keeping the economy secure. Since the early nineteen hundreds the overall time period of economic growth has steadily exceeded the time of economic recession. The Great Depression was an occurrence that will hopefully not occur again, or at least not any time in the near future. With the knowledge the government now has, the economy will most likely get better, or at least keep a level of stability that is satisfactory.
Question about monetary
How long a monetary judgement stays in the credit history?Is it still possible to get new credit cards and refinance the home mortgage if a monetary judgement is in your credit file?
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18 Responses
Monetary policy – actions that directly affect the money supply (e.g., adjusting the bank's reserve requirement, adjusting the interest rate at the Federal Reserve window, Gummint buying and selling US Treasuries)
Fiscal policy – actions that cause a financial impact on the economy. Raising/lowering taxes, adjustments to transfer payments, etc.
Keynes didn't talk so much about money as a remedy to anything, he did write about money but in a different context- more philosophical not at all in the context the Milton Friedman talked about the money stock.
Anyway, Keynes argued for a few pieces of fiscal policy to stop or ease a contraction. His basis was that in a contraction period (i use contraction instead of depression or recession or whatever- all of which are types of contractions of GDP) demand and expectations are what shifts, as such people stop consuming so much and investments (more than consumption even) gets frozen. This freeze in investment capital further hurts growth and further diminishes demand thereby making contraction heavy and painful.
Therefore, Keynes argued, autonomous spending (government) should take it's place by creating jobs and buying goods/ services from the private sector. Create roads, dig holes- fill the holes- dig them up again- whatever you can. He said that even within a deficit, there are 2 reasons why you shouldn't hold back even so; 1) that though gov may be spending in deficit but some of the jobs created and purchases influenced by these policies will end up coming back to the government in taxed, direct and indirect (income- direct, sales tax- indirect). 2) that If you keep people working then you in effect preventing more downturn and even greater loss of revenue if you were to do nothing.
Now, if I can be political for a second. All presidents have been Keynesian for a while. Like Nixon said "we are all Keynesian s now". All governments use this model even outside of a contraction, and the biggest- middle of the road critique of this model is that it's too much of an excuse for governments to spend. Keynes essentially gave federal governments a blank check to mortgage the people in the future. Other critiques argue whether this actually works- though I believe it does, it just doesn't change the production possibility frontier, therefore it cannot sustain growth beyond what was already there b/f this process got started; thereby not working past a few years at a time….
It doesn’t look so good does it? I won’t live in fear but I’d rather be safe than sorry and prepare. But most of all I will get busy doing what ever I can as a citizen to determine in what ways to work towards bringing this to an end. Mails, blogs, letters, faxes, marches, protests whatever it takes short of violence is what I am willing to do to help save this country for my children.
prepare for the bartering system
#1
Hi,
NO GAS- yes we sat in big fat american cars and waited in line for gas;http://en.wikipedia.org/wiki/Image:No_gas_1974.gif
Fiscal Policy is the spending and taxing policy.
Monetary policy is really what the fed does – rates and liquidity and money supply – think of the fed as the mechanic standing by with the oil can – but sometimes they reach in and wipe away the oil. I think it was Greenspan (maybe Volker) who said the fed;s job was to take away the punch bowl before the party got too wild.
To keep that analogy going – the fiscal policy gang (congress and executive branch plus the sates) are the guys who decide to let you in for free – you can pay later – or you can pay more and maybe decide not to show up. They might also decide that since the fed took away the punch bowl they may need to stepin to by the beer to keep the brewers in business.
This is pretty basic stuff so you should be able to find plenty of info.
One of my favorite places to go for this type of info is actually the federal reserve.
The way the fed works there is the main Board of governors and then a bunch of regional feds. Each has its own special focus. For example the Dallas fed will have a ton on energy, the NY fed on Financial Markets.
If you are looking for a basic overview the fed as a student site:
http://www.federalreserveeducation.org/PFED/
However I will put some links below that might help, since the fed does not have a totally unified site:
Now to give my two cents:
Taxes have gone down.
Rates are low.
The prime rate used to be a rate that banks offered to their most credit worthy borrowers- it is now just a really used as a base for adjustable consumer loan rates. (such as a credit card at Prime+4%). The prime rate is set by each bank itself – but pretty mucha ll banks have the same rate. Today;s prime rate is 5%
Today's ecomony is either in or at the brink of a recession.
Here is your ace high marks – this is like the mid-70's oil embargo, inflation fears, weak president. In fact we still have trouble with Iran. Just google jimmy carter-oil crisis-iran hostage crisis- Only this time we are in Afganistan and not the russians.
In the long term, fiscal policy.
In the short term, monetary policy.
Guess which time frame is the only one politicians care about?
Guess which one affects our future?
This is why Milton Friedman was such a critic of monetary policy.
Yes. Interest rates, taxes (on gasoline or foreign goods, for example), tax cuts, treasury buybacks, central bank dealings in foreign currency and gold, etc. The politicians have a lot of tools. Better to get a book on macroeconomics and read to your heart's content.
They can do so by lowering the interest rate and increasing the money supply.
1. Balance of Payments "problem":
When the dollar is weak, that means that exports are relatively inexpensive for other countries to purchase (1 Euro buys more than it used to). The counterpoint of that is that imports are relatively expensive for us to purchase (1 Dollar buys less than it used to). If you're in a trade deficit, you should try to weaken the dollar, which will increase exports and decrease imports. Policies that accomplish this are expansionary monetary policies (Fed buys bonds, cuts interest rates).
Thinking about the rest of these in terms of the problems doesn't make much sense. You're better off thinking about them in terms of what the government's policy options are and what effects those have, then applying them to different problems as they arise.
Expansionary monetary policy (Fed buys bonds, cuts interest rates, cuts reserve rate) increases inflation, increases growth, decreases unemployment.
Contractionary monetary policy (Fed sells bonds, increases interest rates and reserve rate) does the opposite of all those things.
Increases in government spending/decreases in taxes increase growth, decrease unemployment, and increases inflation.
Decreases in spending/increases in taxes does the opposite.
It’s done, jump on hard assets especially gold and silver to prepare. Also, keep food, weapons and ammo because with this type of decline there will be some rough times. Hell, I bought a chainsaw last year and I’ve been stocking up wood like crazy. Just do whatever you can.
@jobedied True Job True..Thanks for telling people this very truth..
@Autotee2 You are right about this Autotee this is all in the Bible..TRUST AND LOVE GOD WILL ALL YOUR HEARTS>>JESUS IS KING OF KINGS AND LORD OF LORDS>>HIS KINGDOM WILL COME>>
explosions and crowd movement are those. I saw this film @ MovieWatcher[.]US
Ultimate goal: One world currency
Fiscal policy, taking the scope of budgetary policy, refers to government policy that attempts to influence the direction of the economy through changes in government taxes, or through some spending (fiscal allowances).
Fiscal policy can be contrasted with the other main type of economic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the supply of money. The two main instruments of fiscal policy are government spending and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy:
* Aggregate demand and the level of economic activity
* The pattern of resource allocation
* The distribution of income.
Fiscal policy is used by governments to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment and economic growth. Keynesian economics suggests that adjusting government spending and tax rates are the best ways to stimulate aggregate demand. This can be used in times of recession or low economic activity as an essential tool in providing the framework for strong economic growth and working toward full employment. The government can implement these deficit-spending policies due to its size and prestige and stimulate trade. In theory, these deficits would be paid for by an expanded economy during the boom that would follow; this was the reasoning behind the New Deal.
During periods of high economic growth, a budget surplus can be used to decrease activity in the economy. A budget surplus will be implemented in the economy if inflation is high, in order to achieve the objective of price stability. The removal of funds from the economy will, by Keynesian theory, reduce levels of aggregate demand in the economy and contract it, bringing about price stability.
Despite the importance of fiscal policy, a paradox exists. In the case of a government running a budget deficit, funds will need to come from public borrowing (the issue of government bonds), overseas borrowing or the printing of new money. When governments fund a deficit with the release of government bonds, an increase in interest rates across the market can occur. This is because government borrowing creates higher demand for credit in the financial markets, causing a higher aggregate demand (AD) due to the lack of disposable income, contrary to the objective of a budget deficit. This concept is called crowding out. Alternatively, governments may increase government spending by funding major construction projects. This can also cause crowding out because of the lost opportunity for a private investor to undertake the same project. However, the effects of crowding out are usually not as large as the increase in GDP stemming from increased government spending.
Another problem is the time lag between the implementation of the policy and detectable effects in the economy. An expansionary fiscal policy (decreased taxes or increased government spending) is usually intended to produce an increase in aggregate demand; however, an unchecked spiral in aggregate demand will lead to inflation. Hence, checks need to be kept in place.
Monetary policy is the process by which the government, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy.[1] Monetary theory provides insight into how to craft optimal monetary policy.
Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates in order to combat inflation. Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation.
Differences in the Effectiveness of Monetary and Fiscal Policies
When the economy is in a recession (when business and consumer confidence is very low and perhaps where deflationary pressures are taking hold) monetary policy may be ineffective in increasing current national spending and income. The problems experienced by the Japanese in trying to stimulate their economy through a zero-interest rate policy might be mentioned here. In this case, fiscal policy might be more effective in stimulating demand. Other economists disagree – they argue that short term changes in monetary policy do impact quite quickly and strongly on consumer and business behaviour. Consider the way in which domestic demand in both the United States and the UK has responded to the interest rate cuts introduced in the wake of the terror attacks on the USA in the autumn of 2001
However, there may be factors which make fiscal policy ineffective aside from the usual crowding out phenomena. Future-oriented consumption theories hold that individuals undo government fiscal policy through changes in their own behaviour – for example, if government spending and borrowing rises, people may expect an increase in the tax burden in future years, and therefore increase their current savings in anticipation of this
Differences in the Lags of Monetary and Fiscal Policies
Monetary and fiscal policies differ in the speed with which each takes effect the time lags are variable
Monetary policy in the UK is extremely flexible (rates can be changed each month) and emergency rate changes can be made in between meetings of the MPC, whereas changes in taxation take longer to organize and implement.
Because capital investment requires planning for the future, it may take some time before decreases in interest rates are translated into increased investment spending. Typically it takes six months – twelve months or more before the effects of changes in UK monetary policy are felt.
The impact of increased government spending is felt as soon as the spending takes place and cuts in direct and indirect taxation feed through into the economy pretty quickly. However, considerable time may pass between the decision to adopt a government spending programme and its implementation. In recent years, the government has undershot on its planned spending, partly because of problems in attracting sufficient extra staff into key public services such as transport, education and health.
Evaluation: Problems with the use of active "demand-management" policies
(1) The measurement of output: Where are we in the cycle? Where are we going? How fast? Will we know when we get there? Inaccuracies in estimating the possible trade-offs in macroeconomic policy
(2) Time lags in the policy process: measurement, decision, execution and then effectiveness of policy changes
(3) What kind of fiscal policy? Spending (on what?) or tax cuts (for whom?)
(4) Will spending (fiscal policy) ‘crowd-out’ other spending, either directly or indirectly?
(5) Will changes in fiscal or monetary policy affect other economic objectives – such as the exchange rate, the trade balance and the provision of public services?
(6) Fiscal policy is weak (ineffective) when investment is very sensitive to interest rates and when consumers pierce the veil and attempt to offset the actions of the government (e.g. saving a tax cut, or increasing their saving when higher government spending leads to expectations of higher taxes in the future)
(7) Monetary policy is weak (ineffective) when consumers are willing to hold large quantities of money rather than spend them even when interest rates are very low
Do not let fear take you over. Go to my page. I believe my outlook is the answer. Many are implementing this outlook. We are not powerless. Do not let fear take you over.
~Namaste
hahahaa you americans are realy stupid