The Fiscal and Monetary Policy and Economic Fluctuations - Essay Example

Interest rates: The benchmark interest rate in the United States was last recorded at 0.25 percent Trading Economics (2013). It was more than 4% in the beginning of 2008, but settled at 0.25% at the year end. Since then, there has been hardly any change in the bank interest rate throughout the period of five years. (Annexure – I) Inflation: It could be observed from the data relating to ‘Inflation in US based on Consumer Price Index’ that inflation was at its peak in October 2008 at 3.655% and at 0.

964% in October 2013. Inflation in US based on Consumer Price Index Year Rate of inflation October 2013 0.964 % October 2012 2.162 % October 2011 3.525 % October 2010 1.172 % October 2009 -0.183 % October 2008 3,655 % Source: globalrates.com (2013) Employment: Unemployment rate was at 6.5 in October 2008 reached its peak at 10 in October 2009 and is currently at 7.3% in October 2013. (Annexure – II) What is the nature of the changes and what are the reasons for the changes? It could be observed that all the indices were at its peak in 2008 around this time, that is five years before.

Interest rate: Reduction in interest rates propelled consumption, consequently demand for the products. Maintaining interest rates at the constant level had its positive impact by keeping inflation under control as well as unemployment, because any increase in interest rates would have fueled inflation which could in turn affect employment negatively due to decrease in demand. Inflation: Inflation would be still under control when the economy recovers from high level of unemployment till full production potential is exploited in the economy.

Inflation has become negative due to high unemployment noticed in 2009, but inched up subsequently as the economy grew and the unemployment situation eased. However, there is considerable improvement in the inflation front in the recent years due to effective monetary policies pursued by Federal Reserve, and it is expected to stabilize around the current levels. Unemployment rate: Increase in demand resulted in increase in production. This has created new demand for labor. The unemployment rate has started coming down from the beginning of 2011.

What are the strategies based on fiscal and monetary policies that will encourage people to spend money in order to create economic growth? Fiscal policy: Government spending at the time of economic slowdown will increase employment. Multiplier effect will set in due to creation of employment opportunities in the economy, since it increases consumption potential of the people. The increase in aggregate demand caused in the process will attract new investments and thus create further employment opportunities.

This cycle continues if the monetary policies are effective in avoiding overheating of the economy. Another important tool in fiscal policy of the government is taxation. For example, by lowering taxes money supply in the economy is increased. Lowering taxes along with or without increase in government spending will therefore be essential for revival of the economy, especially during recessions. Both government spending and taxation, the most important fiscal tools, will have long term impact on the economy.

Decrease in government spending and reduction in tax rates could be more effective to avoid overheating in an economy. However, factors like huge accumulated budget deficits and precarious balance of payments position may