What Is Fiscal And Monetary Policy Pdf
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- Monetary Policy vs. Fiscal Policy: What's the Difference?
- Board of Governors of the Federal Reserve System
- Board of Governors of the Federal Reserve System
Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing borrowing by banks from each other to meet their short-term needs or the money supply , often as an attempt to reduce inflation or the interest rate , to ensure price stability and general trust of the value and stability of the nation's currency. Monetary policy is a modification of the supply of money, i.
Monetary Policy vs. Fiscal Policy: What's the Difference?
Equally, the investment decisions made by corporations can have an important impact on the real economy and on corporate profits. But individual corporations can rarely affect large economies on their own; the decisions of a single household concerning consumption will have a negligible impact on the wider economy. By contrast, the decisions made by governments can have an enormous impact on even the largest and most developed of economies for two main reasons.
First, the public sectors of most developed economies normally employ a significant proportion of the population, and they are usually responsible for a significant proportion of spending in an economy. Second, governments are also the largest borrowers in world debt markets. Government policy is ultimately expressed through its borrowing and spending activities.
In this reading, we identify and discuss two types of government policy that can affect the macroeconomy and financial markets: monetary policy and fiscal policy.
Monetary policy refers to central bank activities that are directed toward influencing the quantity of money and credit in an economy.
Both monetary and fiscal policies are used to regulate economic activity over time. They can be used to accelerate growth when an economy starts to slow or to moderate growth and activity when an economy starts to overheat. In addition, fiscal policy can be used to redistribute income and wealth. The overarching goal of both monetary and fiscal policy is normally the creation of an economic environment where growth is stable and positive and inflation is stable and low.
Crucially, the aim is therefore to steer the underlying economy so that it does not experience economic booms that may be followed by extended periods of low or negative growth and high levels of unemployment. In such a stable economic environment, householders can feel secure in their consumption and saving decisions, while corporations can concentrate on their investment decisions, on making their regular coupon payments to their bond holders and on making profits for their shareholders.
The challenges to achieving this overarching goal are many. Not only are economies frequently buffeted by shocks such as oil price jumps , but some economists believe that natural cycles in the economy also exist. Moreover, there are plenty of examples from history where government policies—either monetary, fiscal, or both—have exacerbated an economic expansion that eventually led to damaging consequences for the real economy, for financial markets, and for investors.
The balance of the reading is organized as follows. Section 2 provides an introduction to monetary policy and related topics. Section 3 presents fiscal policy. The interactions between monetary policy and fiscal policy are the subject of Section 4.
A summary and practice problems conclude the reading. In this reading, we have sought to explain the practices of both monetary and fiscal policy. Both can have a significant impact on economic activity, and it is for this reason that financial analysts need to be aware of the tools of both monetary and fiscal policy, the goals of the monetary and fiscal authorities, and most important the monetary and fiscal policy transmission mechanisms.
Governments can influence the performance of their economies by using combinations of monetary and fiscal policy. The two sets of policies affect the economy via different mechanisms. Money fulfills three important functions: It acts as a medium of exchange, provides individuals with a way of storing wealth, and provides society with a convenient unit of account.
Via the process of fractional reserve banking, the banking system can create money. The amount of wealth that the citizens of an economy choose to hold in the form of money—as opposed to, for example, bonds or equities—is known as the demand for money. There are three basic motives for holding money: transactions-related, precautionary, and speculative. The nominal rate of interest is comprised of three components: a real required rate of return, a component to compensate lenders for future inflation, and a risk premium to compensate lenders for uncertainty e.
Central banks take on multiple roles in modern economies. Although they may express their objectives in different ways, the overarching objective of most central banks is price stability. For a central bank to be able to implement monetary policy objectively, it should have a degree of independence from government, be credible, and be transparent in its goals and objectives.
The ultimate challenge for central banks as they try to manipulate the supply of money to influence the economy is that they cannot control the amount of money that households and corporations put in banks on deposit, nor can they easily control the willingness of banks to create money by expanding credit.
Taken together, this also means that they cannot always control the money supply. Therefore, there are definite limits to the power of monetary policy. The concept of money neutrality is usually interpreted as meaning that money cannot influence the real economy in the long run. Inflation targeting is the most common monetary policy—although exchange rate targeting is also used, particularly in developing economies.
Quantitative easing attempts to spur aggregate demand by drastically increasing the money supply. Fiscal policy involves the use of government spending and revenue raising taxation to impact a number of aspects of the economy: the overall level of aggregate demand in an economy and hence the level of economic activity; the distribution of income and wealth among different segments of the population; and hence ultimately the allocation of resources between different sectors and economic agents.
The tools that governments use in implementing fiscal policy are related to the way in which they raise revenue and the different forms of expenditure.
Governments usually raise money via a combination of direct and indirect taxes. Government expenditure can be current on goods and services or can take the form of capital expenditure, for example, on infrastructure projects. As economic growth weakens, or when it is in recession, a government can enact an expansionary fiscal policy—for example, by raising expenditure without an offsetting increase in taxation.
Conversely, by reducing expenditure and maintaining tax revenues, a contractionary policy might reduce economic activity. Fiscal policy can therefore play an important role in stabilizing an economy.
Although both fiscal and monetary policy can alter aggregate demand, they work through different channels, the policies are therefore not interchangeable, and they conceivably can work against one another unless the government and central bank coordinate their objectives. Download the EPUB available to members. We were not able to record your PL credits. Please try again.
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Board of Governors of the Federal Reserve System
Product and service reviews are conducted independently by our editorial team, but we sometimes make money when you click on links. Learn more. Fiscal policy is a crucial part of American economics. Both the executive and legislative branches of the government determine fiscal policy and use it to influence the economy by adjusting revenue and spending levels. Fiscal policy is paramount to successful economic management since taxes, spending, inflation and employment all factor into gross domestic product GDP. This figure details the value of goods and services produced by a nation within a year. To see how fiscal policy can affect the economy, consider a fiscal expansion that leads to rising demand, which, in turn, increases production.
Fiscal policy involves the use of government spending, direct and indirect taxation and government borrowing to affect the level and growth of aggregate demand in the economy, output and jobs. Fiscal policy is also used to change the pattern of spending on goods and services e. Welfare protection is the largest single element of government spending in the UK, with the NHS and Education the biggest single departmental items. The overall breakdown of government spending across key categories is illustrated in the chart below:. The three main areas of government spending are. Government spending is also a means of redistributing income within society e.
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Board of Governors of the Federal Reserve System
Monetary policy refers to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth. Fiscal policy refers to the tax and spending policies of the federal government. Fiscal policy decisions are determined by the Congress and the Administration; the Fed plays no role in determining fiscal policy. The U.
There are two types of fiscal policy. The idea is to put more money into consumers' hands, so they spend more. The increased demand forces businesses to add jobs to increase supply.
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