Monetary Policy and Gross Domestic Product - Essay Example

?Business Cycle Business cycle is essentially the rise and decline of economic activity. There is no specific or clear-cut span of time that determines a business cycle and the same may range for several years. Referred to as individual cycles, each one illustrates ups and downs that “vary substantially in duration and intensity” (McConnell and Brue 134). There are four phases of the business cycle that comprises of peak, recession, trough and recovery. Peak occurs when the business has reached a transitory high. Full employment is nearest capacity in this phase. Next, recession follows the peak which is characterized by decline lasting for six months or more in terms of income, employment, trade and total output. Prolonged recession is turned into a depression. The third phase, trough, is when the factors affected in recession ‘bottoms out’ to its lowest. The last phase of recovery is when and employment output rise. The variation in duration and intensity is different among business cycles and a number of economists refer to it more often as fluctuations (ibid). A widely used measurement of output is the Gross Domestic Product (GDP) of a country which sees peaks and lows. The bureau created to monitor recessions is the National Bureau of Economic Research (NBER). From 1929 the United States has undergone through 14 recessions with the Great Depression in the 1930s being the worst in history. It was a period of joblessness and homelessness among the population where national output plummeted by 25% (Boyes and Melvin 135). These phases can be seen in the scale of different businesses as well as in the context of any nation’s economy. Fiscal policy and Fiscal Tools The occurrence of business cycles and its concurrent effect on increasing unemployment and inflation prevents economic growth. The mandate of a country to influence economic activity is the central purpose of fiscal policy. The goal of stabilizing the economy became intense because of the Great Depression during the 1930s which paved the way to the Unites States’ application of Keynesian economics. Macroeconomic theories are utilized in the formulation of the scope and limitations of fiscal policy. An example of a direct reaction of the government founded on fiscal policy is the Employment Act of 1946 when unemployment became a major problem after World War II. It categorically defined employee and enables the Federal government to enforce acceptable means necessary to promote employment for economic stability (McConnell and Brue 214). These statues as well as other directives from the government are factors that shape a country’s fiscal policy. Prior to the Great Depression, national government intervention was limited to foreign policy and national defense. Most of fiscal policies are determined in state levels of government who had ample discretion in the formation of their own guidelines. Economists often refer to another important factor in the determination of economic dynamics in the form of political influence as a major factor in the federal budget. When there is unsupervised spending by politicians into particular interests groups then this could lead to exhaustive government expenditure relative to the tax revenues and leads to federal budget deficits (Boyes and Melvin 248). Staggering budget deficits is a major problem for any economy that brings imbalance to the entire system and impedes growth bringing adverse effects to members of a country’s population. There are two broad categories of fiscal tools as enumerated by McEachern as automatic stabilizers and discretionary. The first are programs that regulate the economy by stabilizing disposable income through the real GDP and consumption. The best example of an automatic stabilizer is income tax which automatically modifies the disposable income of an individual. The second is a direct manipulation by the government to encourage its macroeconomic objectives including full employment, growth and price stability. They may differ in the length of execution and as to whom and how they may be carried out. The 2009 stimulus plan implemented by President Obama is a good example of a discretionary fiscal tool adopted by the U.S. Government (254). The government’s fear of another Great Depression leads it to consider measures that may at times seem drastic to ensure all means to thwart it had been attempted. These discretionary tools are often put into effect at unusual times in the economy where the government deems it fit to do something to balance the status of the economy in the interest of the majority. The current recession has prompted many changes and policies that tend to be geared toward discretionary fiscal tools as necessitated by the atmosphere of the times. The basic premise of macroeconomics is to define and map out the occurrences in the economy and the formulation of principles according to measures that may aid in the sound process of promoting economic growth. Monetary Policy “The monetary policy operates through the changes in the quantity of money. An increase in the supply of money decreases the rate of interest, increasing investment and hence aggregate demand and thus increasing the equilibrium level of output” (Deepashre and Agarwal 4.2). This expounds on the role of a nation’s central bank to maintain stability of the money supply and the viability of the currency. As suggested, the quantity of money must be directly proportionate to the reserves of the country. Overproduction of money would result to its decrease in value since they do not appropriately represent their worth in connection with the actual available federal reserves. The Federal Reserve Board of the United States is responsible for the monetary policy of the country which determines the changes of money supply which is directly significant in the standard interest rates which correlates to the economic spending. “The goal is to achieve and maintain price-level stability, full employment and economic growth” (McConnell and Brue 268). The Federal Reserve Banks exemplifies the assets, liabilities, securities, treasury deposits and reserves encompassing the coffer of the government. There are three monetary policy tools applied by the Fed to control the reserves of commercial banks, namely, open-market operations, reserve ratio, and discount rate. In open-market operations, buying securities and selling securities as government bonds differ between commercial banks and from the public. The reserve ratio determines commercial banks’ capacity to extend loans in accordance with the allowed reserve ratio of the government. Discount rate is the short-term loans provide by Federal Reserve Banks to commercial banks through promissory notes secured by collateral in the form of government securities (ibid 270-274). Bibliography Boyes, William, and Michael J. Melvin. Principles of Macroeconomics. 8th ed. Mason, OH: South-Western Cengage Learning, 2011. Google Books. Web. 10 Dec. 2012. Deepashree, and Vanita Agarwal. Macroeconomics. New Delhi: McGraw-Hill, 2007.Google Books. Web. 10 Dec. 2012. McConnell, Campbell R., and Stanley L. Brue. Macroeconomics: Principles, Problems, and Policies. 16th ed. Boston: McGraw-Hill, 2005. Print. McEachern, William A. Macroeconomics: A Contemporary Introduction. Cincinnati, OH: South-Western College Pub., 2000. Google Books. Web. 10 Dec. 2012. Read More