Compare and comment fiscal policy and monetary policy

Question

Compare and comment fiscal policy and monetary policy

Answer 1

Fiscal Policy

Federal taxation and spending policies designed to level out the business cycle and achieve full employment, price stability, and sustained growth in the economy. Fiscal policy basically follows the economic theory of the 20th-century English economist John Maynard Keynes that insufficient demand causes unemployment and excessive demand leads to inflation. It aims to stimulate demand and output in periods of business decline by increasing government purchases and cutting taxes, thereby releasing more disposable income into the spending stream, and to correct overexpansion by reversing the process. Working to balance these deliberate fiscal measures are the so-called built-in stabilizers, such as the progressive income tax and unemployment benefits, which automatically respond countercyclically. Fiscal policy is administered independently of Monetary Policy by which the Federal Reserve Board attempts to regulate economic activity by controlling the money supply. The goals of fiscal and monetary policy are the same, but Keynesians and Monetarists disagree as to which of the two approaches works best. At the basis of their differences are questions dealing with the velocity (turnover) of money and the effect of changes in the money supply on the equilibrium rate of interest (the rate at which money demand equals money supply).

Monetary Policy

Actions by the Federal Reserve System to influence the cost and availability of credit, with the goals of promoting economic growth, full employment, price stability, and balanced trade with other countries. Through its monetary policy decisions, the Fed tries to regulate both interest rates and the nation's Money Supply. Monetary policy is carried out by the Federal Reserve Board and the Federal Open Market Committee, the 12-member committee (including all 7 governors of the Federal Reserve Board), which directs the open market purchase and sale of government securities for the 12 Federal Reserve Banks. The Federal Reserve Board chairman appears before Congressional committees twice a year, in February and July, to report on Federal Reserve monetary policy objectives, as required by the 1978 Humphrey-Hawkins Act. These addresses are watched closely for indications of a change in monetary policy.

The Fed has at its disposal three distinct tools of monetary policy: the purchase or sale of securities through Open Market Operations its power to set financial institution Reserve Requirements and the Discount Rate paid by banks and savings institutions when they borrow from one of the district Federal Reserve Banks. Monetary policy can be characterized as being either tight credit or easy credit. When the Fed is worried that the economy is growing too fast or prices are rising too rapidly, it tightens up reserve positions by selling government securities or allowing maturing securities to run off. This process is known as draining reserves. If, on the other hand, the Fed becomes concerned that the economy is not growing fast enough, or is headed into a recession, it can inject new reserves into the banking system by buying securities from securities dealers. By buying, instead of selling, securities, the Fed is expanding, rather than contracting the supply of bank reserves, thereby making it easier for banks to meet their reserve requirements and make new loans.

In addition to monetary policy, the Fed also has several selective credit controls regulating the cost of credit. These include the Margin requirements on securities purchased through broker-dealers, and the highly effective Moral Suasion whereby the Fed tries to persuade bankers to go along with its recommendations through informal pressure. Although monetary policy differs from the federal government's Fiscal Policy , carried out by its tax and spending policies, both share a common objective: balancing aggregate demand in the economy against aggregate supply, as measured by the gross national product, employment, and interest rates, thereby keeping inflation and unemployment under control.