Monetary and Fiscal policies - Research Paper Example

Running head: Monetary and fiscal policies 13th April Monetary and Fiscal policies Outline: Monetary and Fiscal policies Monetary policies refer to the strategies adopted by central banks to regulate money supply. On the other hand, fiscal policies entail the government techniques to enhance economic development and attract investors. Examples of fiscal policies include reduction of taxes, increasing government spending as well improving infrastructure system. Central banks are responsible for enacting monetary policies in order to trigger economic growth and mitigate inflation.

In this regard, monetary policy is important based on its fast response to address economic problems. In the same way, monetary policies are formulated and implemented by economics experts thus making it effectively match the fiscal policies adopted by governments. Two major strategies adopted by central banks to regulate money supply are contractionary and expansionary monetary policies. While contractionary policies are aimed at slowly expanding money supply, expansionary policies expand the money supply in a rapid move.

The major types of monetary polices are fixed exchange rate, floating exchange rate and inflation targeting. In their effort to address inflation and deflation, central banks emulate various monetary policy tools. These include monetary base, reserve requirements, discount lending rates, exchange requirements, margin requirement, regulation of consumer credit and moral suasion. Being the regulator of exchange market, central bank has vital responsibility of determining the exchange rates. However, market forces can significantly influence the interest rates.

In order to arrive at an appropriate exchange rate, central bank considers various factors that include inflation rate differences, deficits in current account as well as differences in interest rate. By adopting various monetary policies, developed country can influence the policies emulated by other countries. For example, when US used floating exchange rates to solve imbalances in the economy, most countries removed barriers of capital flows to put free market philosophies. Fiscal policies involve the strategies adopted by government to propel economic growth.

These include government spending, borrowing and taxation. One of the fundamental aspects of fiscal policy is that it ensures proper management of demand. This involves increment of government spending on various sectors such as transport and health. Major components of fiscal policy are transfer payments, current government spending and capital spending. Being a major source of government revenue, taxation is categorized into two major classes namely direct and indirect taxes. In the same way, depending with the response of the tax rate on the incomes, tax can be grouped into three major groups.

These include progressive tax, proportional tax and regressive tax. Enhancement of supply side of the economy is one of the vital roles of fiscal policies. To expand the supply and improve the economic productivity of a country, governments undertake various fiscal policies. These include labor market incentives, capital spending, creation of new businesses, research and development, as well development of human capital. The relationship between national income investment, government expenditure and consumption can be summarized using the equation Y = Cd + Id + Gd + X.

Where Cd is the consumption of domestic services and goods, Id represents the domestic investments, Gd is the government expenditure incurred in purchasing domestic goods and services while X represents the goods and services exported to foreign countries. Just like monetary policies, fiscal policies in developed country can be transmitted to other countries in various ways for example if the US government reduces its military expenditure, it will withdraw its military from other countries. In turn, other countries will increase their expenditure on security.