An overview of monetary policy and fiscal policy
The two most well-known tools used to affect a country’s economic activity are monetary policy and fiscal policy. The administration of interest rates and the total amount of money in circulation constitute the main objectives of monetary policy, which is often carried out by central banks like the U.S. Federal Reserve.
The word “fiscal policy” refers to a government’s overall taxing and spending decisions. The executive and legislative branches of government in the United States decide on the country’s budgetary policies.
Monetary policy has usually been employed by central banks to either boost or restrain economic growth. The goal of monetary policy is to promote economic activity by providing incentives for people and corporations to borrow and spend money. On the other hand, monetary policy can serve as a brake on inflation and other problems brought on by an overheated economy by limiting spending and encouraging saving.
Open market operations, altered reserve requirements for banks, and altering the discount rate are three of the Federal Reserve’s most often employed policy measures. The Fed buys and sells U.S. government bonds every day in open market operations to either add money to the economy or remove money from circulation.
The Fed directly affects how much money is created when banks issue loans by determining the reserve ratio, or the portion of deposits that banks must hold in reserve. In order to influence short-term interest rates throughout the entire economy, the Fed can also target changes in the discount rate (the interest rate it levies on loans it makes to financial institutions).
The real economy is less affected by monetary policy, which is more of a blunt tool for adjusting the money supply to affect inflation and growth. The Fed, for instance, exercised strong policy during the Great Depression. Although its policies avoided deflation and economic collapse, they did not result in a sufficient increase in the economy to make up for the lost productivity and employment.
By raising asset prices and cutting borrowing costs, expansionary monetary policy can boost corporate profits while having a minimal impact on GDP.
In general, the goal of most government fiscal policies is to target the overall level, total composition, or both of the spending in an economy. Changes to government spending or tax policies are the two most frequently used ways to influence fiscal policy.
Governments have the option to raise their spending—often referred to as stimulus spending—if they feel there is not enough economic activity. Governments borrow money by issuing debt securities like government bonds and, in the process, amass debt if tax revenues are insufficient to cover the increases in spending. Spending in deficit is what is meant by this.
Governments drain money from the economy and stifle business development through raising taxes. Typically, when a government wants to boost the economy, fiscal policy is used. To promote economic expansion, it may decrease taxes or provide tax breaks. One of the fundamental principles of Keynesian economics is the use of fiscal policy to affect economic results.
A government must decide where to spend money or what to tax when it alters tax laws. In order to encourage or discourage production, government fiscal policy might thus target certain towns, industries, investments, or commodities; occasionally, its decisions are influenced by factors other than economic ones. Due of this, economists and political commentators frequently engage in spirited discussion on fiscal policy.
In essence, it aims to increase total demand. Companies gain because of the higher revenues. However, expansionary fiscal policy runs the danger of causing inflation if the economy is close to reaching its potential. This inflation depletes the funds of people on fixed incomes as well as the profit margins of some businesses in cutthroat industries who may find it difficult to pass costs on to customers.
The management of the economy is greatly influenced by both monetary and fiscal policy, both of which have both direct and indirect effects on the finances of individuals and households. The government makes decisions about taxes and spending that affect individual taxpayers’ tax bills or provide them jobs on government projects. The central bank determines monetary policy, which can increase consumer spending by lowering borrowing costs for everything from credit cards to mortgages.