Expansionary Economic Policy - Essay Example

Expansionary economic policy America used to embrace the philosophy of Laissez Faire in the past and this made the United States government to perform minimal roles in monitoring and controlling the economy. However, as time went by, the philosophy underwent a radical change and took a new course that was different from the parent one. The radical change has brought the understanding of the most important roles that are to be played by the federal government, which includes the role of regulating and stabilizing the economy of the country. The terms monetary and fiscal policy have almost a similar meaning but with only a slight difference. Fiscal policy stands for the power possessed by the federal government to tax as well as spend with an intension of achieving the goals of the economy. On the other hand, monetary policy deals with the important programs that make an attempt of increasing or decreasing the nation’s level of business activities through the legal regulation of money supply and credit. Despite the difference between the two, they both have a common goal of either decreasing or increasing the level of the business activities. A better understanding of the above two terms and what they stand for can be handled in the following subheadings. The Theory of Monetary and Fiscal Policy The theory of monetary and fiscal policy reveal that monetary policy stands for the whole process through which the central bank, government, and even the monetary authority are able to take control over three major aspects. The three major aspects include the money supply, interest rates that are meant to achieve the set objectives of stabilizing the economy, and availability of money in the economy. The monetary theory reflects on how one can be able to design the optimum monetary policy without interfering with the lives of other people. The theory goes further to give a suggestion that the monetary policy tends to rest on the relationship that exists between the price at which money can be borrowed, interest rates in an economy, and the total amount of supply of money (Persson 45-46). In addition, the money and fiscal policy make use of several tools in controlling the country’s economic growth, the exchange rates, as well as inflation. It must be noted that the exchange rates can only happen when there is another currency from a foreign country. However, if the currency tends to be under a monopoly of issuance, then there exist high chances that the regulation system might issue the currency through the existing banks, which might end up being tied to a central bank that can easily be controlled by the authority in altering the money supply and influencing the interest rates. The theory gives an overview of the roles played by the policymakers in regulating the inflation in an economy. Policymakers play a big role in making time-to-time credible announcements that are aimed at informing the citizens on the changes in the interest rates and the amount of money available for borrowing. The theory reflects on the two ways in which the decision made by the policymakers can affect the inflation. In the first case, if firms and other consumers are made to believe that policymakers are working towards lowering the inflation, then there is a likelihood of a true anticipation of lower prices in the near future compared to the current ones. On the other hand, if employees tend to expect high prices in the near future, then there are high chances for employees to draw contracts that entail high wages. This is because employees aim at covering up the high prices in the economy through earning a relatively higher income. However, in an ideal economy, there is always a likelihood of introduction of a wage-setting behavior that is meant to solve such cases that have been mentioned above. The wage setting behavior attempts to balance the relationship between the employee and employer. In case the employees are receiving lower wages that cannot meet the demands of the high prices, then the settings erode the demand-pull inflation. On the other hand, if employers are realized to be giving out small wages, then the settings erode the cost push inflation to enable the employers cater for the cost of other essential resources. According to the theory, policymakers are expected to make most credible announcements that will make the private agents believe that the announcements made will directly reflect on the actual future policies. However, in the case of existence of low-level inflation targets, the private agents might not trust the targets and the wage setting may turn up supporting the anticipation of high-level inflation, which might lead to increase in prices (Persson 56). The theory reflects on the opinion of the policymakers, which supports the aspect of low-inflation that is always the desire of the private agents. In such cases, policymakers implement the expansionist monetary policy that enables the policymakers to hike the prices without the knowledge of the private agents. However, the failure of the expansionary monetary policy might primarily be caused by the possibility of making credible announcements by the policy makers. Reasons Of 2008 US Economic Crisis It might be beyond imagination for one to reflect on such a developed country to undergo any economic crisis. America has always been stable in controlling its economy. However, in the year 2008, the economic crisis in the United States marked one of the historic events that might take years to fade from the individuals’ memory. There are many reasons that led to such a crisis and the most outstanding ones are as discussed below. The first reason concerns the long-term structural economic problems. America has been experiencing debt accumulation per person for many years. By the year 2008, the US government realized that too much debt had accumulated and it called for the government to settle part of it. This meant that most of the companies, households and the government were to put aside other activities and concentrate on reducing the worsening debt. According to Irving Fisher, who was an American economist, this caused the debt inflation that led to the deterioration of the economy. In addition, it has to be noted that America wasted many of its resources on the two wars that ran from 2002 to 2008. These made America realize that it had spent a lot of money in protecting the rest of the world and in the year 2008, the country was almost bankrupt (Freedman 34-36). Furthermore, the short-term catalysts from the financial crash show the causes of the economic crisis in America. The weak mortgage regulation as well as the low interest rates supported the speculations that led to bubbling of the real estates and the mortgage boom. The most outstanding element of the boom was the front line lenders who encouraged frauds, which supported them in reselling the loans to scrutinized pools. The Mortgage Asset Research Institute revealed the story of the unchecked frauds, which might have led to the deterioration of the economy. This meant that most of the transactions were untaxed and the government received little from the taxation. Monetary and Fiscal Policy Used By US Government to Overcome the 2008-2012 Recession The US government retaliated towards the great recession by using the most aggressive monetary and fiscal policies that have never existed before in history. However, the response was largely multifaceted as well as bipartisan, in which the Congress, Federal Reserve, and the administration were involved in the process. Despite the effectiveness of both the monetary and fiscal policy in overcoming the great recession, critics still consider the policies to be misguiding. Furthermore, a series of debates that were held over the policies, made the matter more critical because the economy was still very weak and this meant the government needed more support. An overview of the Moody’s Analytics model reveals the adjustment of the financial market policies, which stimulated the macroeconomic effects of the US government total policy response. However, the effects of the model on jobs, GDP, and the inflation were speculated to be huge and rated under the great depression 2.0. The speculation of the impact brought by the model mentioned above led to the division of the effects into two major components. One of the components was attributable to fiscal stimulus and the other one was attributable to the fiscal market policies. Reflections of the effects brought by fiscal stimulus prove to be substantial in upgrading the GDP by approximately 3.4%. The government’s stimulus seems to have been unpopular and the general perception reveals that the stimulus did very little in changing the economy. However, the fiscal stimulus turned out to be successful in ending the great recession and at the same time, it led to the recovery of the economy. It was greatly associated with the American recovery and reinvestment act, which mobilized the 784 billion US dollars package that led to temporal increase in spending and tax cuts. In addition, the most outstanding forms of the fiscal policy have been inculcated in the government’s response to any recession that might occur at any time. The attractive features of the fiscal policy have made it effective in overcoming the recessions. The most profound feature that is embedded under the fiscal stimulus is the extended unemployment benefits. It offers the necessitated financial help to both the state and the local government. According to the constitution, all states in America are legally bound to balance their respective budgets. This is because during any recession, the economy is normally characterized with budget short falls. It means that the private agents might be forced to pay more tax in absentia of the federal aid. Therefore, the fiscal policy makers saw the need of working on tax cutting as well as reviewing the increase in expenditure by the private agents. Despite the effectiveness of the fiscal stimulus in handling the great recession, relatively large amount of the fiscal stimulus might lead to extraordinary downturns and might end up reducing the effectiveness of the monetary policy. This is because the interest rates might be approaching zero and this may lead to imbalance in the equilibrium of the economy. In addition to this, the Federal Reserve jobs tend to be complicated by the most significant risk of deflation. This is because the Federal Reserve might not be in a position to lower the nominal rates, which may end up lowering the prices and make the unemployment approach double digit. In addition, the aspect of the government of overusing the spending rather than tax cutting supports persistence of high unemployment in the economy (Freedman 49-52). Articulation of the interest rates, stock prices and implementation of the monetary policy, significantly participated in overcoming the great recession. The monetary policy was largely captured in the model that improvised the federal funds rate target. The funds rate equation has always been considered part of FOMC as put forward by Taylor. The framework reveals that the funds rate target has always stood out as a function that tends to estimate the real growth potential. It goes further in explaining the difference between the actual inflation rate and the target inflation rate. Handling of the financial crisis could not have been managed by the monetary policy. A strong back up of the Federal Reserve assets was added to the model in overcoming the recession. This gave an implication that reflected on the nature of the funds rate that gave positive results of making the equation to exceed zero by a big margin. This led to an increase in capital that was achieved through lending via the banking systems. The significant increment in the capital that was funded through the banks and the federal government brought the realization of the benefits of both the monetary and the fiscal policy, which gave a strong back up in restoring the stability of the short term funding markets. However, the most outstanding long-term interest rate in the model was the yield on the ten year Treasury bond that turned out to be key determinant of the corporate and mortgage rates. Analysis and Comments on the Monetary and Fiscal Policy The monetary and fiscal policy can be best analyzed through the most evidential task that reflects on a certain process in the United States. The true accounts of history reveal that America slid into recession way back in 1929. However, economists relied so much on the classical theory of economics that gave a suggestion of the self-correction of the economy given that no government interferences are encountered. However, when recession deepened in the great depression, the theory proved void and meaningless because it could not solve the problem. This called for a revision of theory for it to include other essential factors in the economy that never existed before. The development of the Keynesian theory called for the government to immediately intervene and correct the economic instability. The congress and the Federal Reserve used several tools in correcting economic problems. The tools ended up affecting the interest rates, aggregate demand, and the money supply. However, a critical analysis of any economic data in determining the way monetary and fiscal policy operates relies so much on how economic problems are corrected. Any economic performance can perfectly be illustrated through the analysis of the aggregate demand and aggregate supply. The aggregate supply can best be understood as the total supply of the available goods and services that are produced in the nation’s economy. Its upward-sloping characteristic is due to the incentive of the firms to produce more when prices are high and produce less when the prices are relatively lower. On the other hand, the aggregate demand can best be understood as the total goods and services demanded by the nation’s economy. Its downward-sloping characteristic is due to the fact that the government, consumers, and even foreign customers are less willing to buy the commodities at relatively higher prices. Graphical representation of the two aspects gives a clear identification of the shifting in both the demand and the supply curves (Freedman 78). In case the confidence of the consumers’ falls in the economy, there is a likelihood that people might end up reducing their expenditure and this will lead to a fall in demand. In addition, this might cause a reduction in the real output as well as the prices and possibly lead the country into a recession. However, if the money supply in the economy turns out to be large, then there is a likelihood of an extraordinary increase in the consumers’ demand, which can push up the aggregate demand and consequently raise the prices and the real output leading the country into a serious inflation. Economy of the country follows a constant economic cycle of expansion and recession in an attempt to attain a stable economic growth. However, Keynes argued that nations are supposed to wait for realistic economic problems to correct themselves. He later advocated that the government plays an active role in solving many economic issues through the effective use of monetary and fiscal policy. Keynes went further in giving a recommendation that advised the congress to increase government expenditure. He also recommended that the Congress is supposed to decrease the tax rates for giving households more disposable income. Keynes reflected on his articulation of the taxes and money supply in the economy as the only way that can be used by the government in reducing the pressure on the aggregate demand. He however, advocated change in the government spending as the perfect fiscal tool due to the impact it has on the aggregate demand. On the other hand, if there is an increase in the taxes, then consumers might end up reducing their consumption of the products in the economy and it can make them spend more on taxes. Monetary policy can be viewed as the use of money supply and credit in stabilizing the economy. The demand for money entails consumers borrowing to buy luxurious items like cars, firms, equipments, and the government borrowing to settle the outstanding national debt. The Federal Reserve Board of Governors normally sets up money supply through the central banking system of America. The demand and supply of money mainly determines the interest rates that are supposed to be paid for the borrowed money. In case the Federal Reserve makes an attempt to reduce the money supply, interest rates will raise and less money will be borrowed as well as spent by Individuals. The table below shows the mentioned behaviors. The Federal Reserve has three primary operational tools that can be used in changing the money supply. Keynes recommends on buying the Fed’s bonds on open market. This tends to increase the reserves held by the bank and, therefore, money can be available to loan. The second tool entails lowering the discount rates in which firms, government, and customers become more willing to borrow as well as spent. The final tool inculcates a reduction on the reserve requirement especially during the serious recession. Economists must have learnt a lot from the Great Depression. Furthermore, many of them advocate a wonderful role for the government in creating a stabilized economy. However, the majority of the economists still recognize the most outstanding advantages of making use of monetary and fiscal policy for the sole reason of preventing extreme inflation. Works Cited Freedman, James. The U.S. economic crisis. New York: Rosen Pub, 2010. Print. Persson, Timothy. Politics. Cambridge: MIT Press, 1995. Print. Read More