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 
 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 
 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 
 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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