Macroeconomics

Introduction to MacroEconomics Fiscal and Monetary Policy

Introduction to Macro-Economics: Fiscal and Monetary Policy Fiscal and Monetary Policy and their differences With an intention of achieving the economic stability of the nations, governments have always taken in account various economic tools such as taxes, public spending, borrowing and debt management. It is in this context that Fiscal Policy is considered as the measures adopted by the government to adjust its level of expenditure with the purpose to monitor and thus influences the economic growth (Gupta, 2007). Similarly, Monetary Policy is the action taken by the central banks of nations, boards or other regulatory committees those are in the authority of determining the size and rate of the money supply which affects the interest rates. Hence, the fiscal and monetary policies are interlinked in relation to the economic structure and development. Monetary policy is maintained through measures like increasing the interest rates provided to the public or maintaining the total amount of bank reserves (Gupta, 2007). 2. The Federal Reserve policy makers and their tools Federal Reserve Board is the authority responsible for monetary policy of the U.S. The tools used by Federal Reserve Board are concerned with open market operations and the federal funds rate. Open market operations include government securities such as notes, bonds and also treasury bills. This method is very important as Federal Reserve Board uses it to single out and implement the policy changes (Lien, 2008). Federal funds rate is the fundamental policy target used by Federal Reserve Board. It is the rate of interest for borrowing U.S dollars that the Federal Reserve Board provides on the basis of its previous day’s closing rate against the US Dollars (USD). Any changes beyond this range during the day will invite the intervention by the central bank in terms of purchasing or selling of US Dollars (Lien, 2008). An expansionary monetary policy has an adverse effect on maintaining the balance of payments (BoP) whereas a contractionary policy intends recovering it. Fall in interest rate is a result of expansionary monetary policy but rise in interest rates are the effect of an expansionary fiscal policy (Cherunilam, 2008). 3. Keynes vs. Friedman There are key differences between the concepts propagated by Keynes and Friedman. Keynes considered the great depression resulted into the failure of the free market whereas Friedman had a different saying. According to Friedman, Federal Reserve had failed. Keynes believed in diplomacy for bureaucrats like himself but Friedman believed that the establishment of safe government was possible only by implementation of rigid rules. Keynes proposed that capitalism should be in shackles whereas Friedman thought it is beneficial to leave capitalism untouched (Skousen, 2007). 4a. President Obama, through the EPA, and with the agreement of the automobile companies, increased the mileage requirements for automobiles sold in the US. The decision taken by President Obama is not related to any of the fiscal or monetary policies. This is the situation of an attempt of upgrading the environment. This decision comes under the National Fuel Efficiency Policy which deals with the Environment Protection Agency (EPA) (The White House, 2011). 4b. For the past several years subsidies have been given for the production of corn based ethanol fuel. This situation is considered within the periphery of the fiscal policy. In this case, the decision taken by the government to provide subsidies for the production of corn-based ethanol fuel is intended to encourage the organizations. Subsidies are a benefit offered by the government to individual or particular groups. Subsidies are generallyprovided in form of reduction in tax or cash payments. Subsidies are provided by the government with an intention of development and to remove the unfavorable circumstances. In simple words, subsidy is the monetary aid provided by the government. 4c. Due to the nuclear crisis in Japan, inspections of United States nuclear plants are taking place and additional safety requirements will be written. The above situation falls within the policy. In this case, government tries to restructure or build up a better infrastructure which is concerned with the implementation of fiscal policy. 4d. There has been some speculation that tax deductions, such as the one allowed for interest on home mortgages, will be eliminated or altered. This decision of reducing tax comes under the fiscal policy as this has a direct affect on the earning and living standards of the people in the economy. Tax reduction is one of the vital tools used by the government to standardize the economy of the citizens. Elimination of tax on the interest of home mortgages is related with an attempt to upgrade the socio-economy of a person. 4e. The Federal Reserve Board of Governors has recently stated they will maintain interest rates at or near their current low levels until 2014. This particular situation deals with the monetary policy of the nation as Federal Reserve Board of Governors are concerned with monetary policy of the US concerning the changes in interest rates. They are responsible for the regulation of the treasury (Federal Reserve Bank of New York, 2011). 4f. When President Clinton was in office during the 1990’s there was an intentional policy of reducing interest rates, both short and long-term. This situation deals with fiscal policy of the nation. This was the step initiated to increase the economic growth of the country. By decreasing the interest rate, entire country was to be benefited and the affect of inflation was to be reduced. 4g. Beginning with the Bush administration and continuing with the Obama administration there was a bailout of the financial system. Here, in this situation monetary policy has been focused. Financial systems of a nation entirely deal with the monetary policy. 4h. Sudden increase of interest rates by Mr. Paul Volker This is the situation of monetary policy. Here, Paul Volker, the Chairman of the Federal Reserve System introduced this sudden increase in interest rate with an intention to control increasing inflation rate. It is worth mentioning that monetary policies deal with the inflation and deflation arising within the economy (Rittenberg Tregarthen, 2010). References Cherunilam. (2008). International economics (5th ed.). India: Tata McGraw-Hill Education. Federal Reserve Bank of New York. (2011). Monetary policy responsibilities. Retrieved from http://newyorkfed.org/aboutthefed/fedpoint/fed46.html Gupta, J. R. (2007). Public Economics in India Theory and Practice. India: Atlantic Publishers Dist. Lien, K. (2008). Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves (2nd ed. illustrated, Rev.). U.S.A: John Wiley and Sons. Rittenberg, L. Tregarthen, T. (2010). Principles of Macroeconomics. Web Books Publishing. Skousen, M. (2007). The big three in economics:Adam Smith, Karl Marx and John Maynard Keynes. M.E. Sharpe. The White House. (2011). President Obama Announces National Fuel Efficiency Policy. Retrieved from http://www.whitehouse.gov/the-press-office/president-obama-announces-national-fuel-efficiency-policy

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