BUSINESS

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Monetary and Fiscal monetary policies application

Topic 1

Monetary policies are resources used by the country’s Central Bank to control the level of spending within its boundaries by increasing or decreasing the amount of money within the economic system. The main difference between contractionary and expansionary monetary policies is that the former is used to reduce the money supple within the economy while the latter increases it. Sexton (2013) states “expansionary fiscal policies are used by governments to decrease unemployment and increase growth by increasing the demand of labor” (pg 520). This is achieved through increasing governments spending and reducing taxation. Contractionary fiscal policies find use in control of inflation by decreasing the money supply within the economy. This is achieved through reducing government spending and increasing taxation. In terms of the Aggregate Demand, contractionary monetary policies decrease money supply in the economy lowering the GDP and consumer spending, while expansionary monetary policies increase the economy’s money supply raising consumer spending by raising the GDP.

Topic 2

The main difference between monetary and fiscal policies in the United States is who formulates them and the level of political influence each is subject to. Driver (2010) reports “fiscal policy is set by elected government bodies, for example, the Congress, making it subject to agreement from both the Congress and President” (pg 86). Due to this, fiscal policy suffers a lot of political influence. Monetary policy, on the other hand is set exclusively by the Federal Reserve making it immune to political influence. The main problems of the US fiscal policy lie in its effects on the national debt. Expansionary fiscal policy leads to the government increasing spending to rates that are faster than it is collecting tax revenues. This in turn increases the national debt since the country has to issue interest-bearing bonds to finance government spending. In addition, issuance of these bonds increases competition in the private sector that is also forced to issue them eventually raising the interest rates and hurting the economy further.

Topic 3

The best way to balance out the short-run tradeoffs between the inflation rate and unemployment rates is to formulate a firm policy to contain inflation. Doing this leads to the public having reduced expectations regarding future inflation that results in a more favorable compromise between inflation and unemployment. Barucci (2003) states that “the rational expectations hypothesis, people naturally use information from government organs regarding economic information about inflation, to formulate their expectations” (pg 73). In this state, macroeconomic policymakers can manipulate the factors and variables at their disposal to balance the short-run tradeoffs between inflation rates and unemployment rates.

References

Barucci, E. (2003). General Equilibrium Theory and Risk Exchange. In Financial markets theory: Equilibrium, efficiency, and information (p. 73). New York: Springer.

Driver, S. S. (2010). Fiscal Policy. In Economic literacy: A complete guide (p. 86). Tarrytown, NY: Marshall Cavendish.

Sexton, R. L. (2013). Macroeconomic Foundations. In Exploring economics (p. 520). Australia: South-Western Cengage Learning.