As promised in my last blog, ECON101: MACROECONOMICS VERSUS MICROECONOMICS, this piece will address the interesting topic of Fiscal and Monetary Policy. Yes, the adjective “interesting” might be subjective, but I believe it is a good ‘next step’ in establishing the foundation for my ECON101 series.
Let’s start with the understanding that there are three main economic goals that are shared globally. These are: growth, high employment, and price stability. There are, what we call, economic indicators that provide information as to how the economy is doing relative to these three goals. Because there are so many indicators, typically most professionals follow a select few. I will take a closer look at each of the goals and key statistics in future blogs.
Collectively individual’s decisions on how they allocate their resources, such as how much to spend versus save, can affect an economy just like similar economic decisions made by corporations can have an important impact. But rarely does an individual corporation or household affect large economies on their own. However, government policy does have the power to affect the macroeconomy and financial markets. And, government policy would be enacted in an effort to attain one or all of the three main economic goals.
So how exactly does the government intercede to meet their three main economic goals? There are two policies they have access to, they are: monetary policy and fiscal policy.
The predominant goal of monetary and fiscal policy is to create an economic state of steady and positive growth as well as stable and low inflation. This is accomplished by guiding the economy in a way to minimize periods of great volatility to include big economic booms followed by lengthy slumps. Stability is important, it provides individuals and corporations the security needed to be able to make spending, investment and saving decisions.
Monetary policy refers to activities carried out by central banks, i.e. the U.S. Federal Reserve, aka “Fed”. These activities are primarily concerned with the management of interest rates and the quantity of money in circulation. These actions can either stimulate an economy or slow an overheated economy.
Three tools the Fed frequently has used are:
Participate in open market operations. This is typically done on a daily basis and is the act of the Fed buying and selling U.S. government bonds. The Fed does this to either add money into the economy or remove it from circulation.
Change the reserve requirement. The Fed controls the reserve requirement (aka reserve ratio). This is the percentage of deposits banks are required to keep in reserve; i.e. unable to lend out. If this is higher banks are unable to lend as much, but if the percentage is decreased, they can lend more which puts more money into the economy.
Establish the discount rate. The discount rate is the interest rate the Fed charges on loans it makes to banks/financial institutions. Obviously, the lower this is the more a financial institution is interested in borrowing and thereby injecting dollars into the economy.
Fiscal policy represents the government’s decisions about taxation and it’s spending. In the United States this is determined by the executive and legislative branches of the government.
Generally, the purpose of most fiscal policies is to affect the total amount of spending, the way it is spent, or both in an economy. This can be accomplished by changing government spending policies or government tax policies.
If an economy is lacking business activity, the government can step in and increase the amount of money is spends (i.e. fix the roads). This is referred to as stimulus spending. Sometimes a municipal’s tax receipts are limited and the government has to borrow money to pay for the expenditures. The government does this by issuing vehicles like bonds thereby accumulating debt. This is known as deficit spending.
Basically, the government can increase or decrease taxes. By increasing taxes, they pull money out of the economy resulting in slowing business activity. If they lower taxes or offer tax rebates the government is keeping or putting more money in the pockets of individuals or corporations. The hope is that the result is increased spending by these individuals or corporations sparking economic growth.
In comparing the two, monetary policy is used in an effort to have an immediate impact to the money supply sparking economic activity. Fiscal policy typically has a greater impact on consumers since it can lead to increased employment and income. Applied together they can have great influence over a country’s economy and its participants.
As I did in my last blog please provide feedback or if you have a specific topic you’d like me to address via https://maximawealth.com/contact/. The feedback I received in the past has been helpful in guiding my future blogs. Thank you!
Look for my next ECON101 discussion during the 4th Quarter where I’ll begin to look into each of the global economic goals.