Fiscal and monetary policy theories and application - Essay Example

Task: Fiscal and monetary policy theories and application Fiscal policy entails the processes through which the government achieves major economic goals through taxes and government spending. The government collects tax and spends it to achieve economic development. Taxation is one of the key avenues though which governments collect revenues from local and foreign residents. Three main aspects that make up fiscal policy include consumption, investment and government spending. In this sense, the government relies on the three aspects of demand to achieve desired economic goals. The desired economic goals include full employment, price stability, economic growth, and maintenance of a favorable balance of payment, The three aspects add up to determine the equilibrium level of the gross domestic product. On the other hand, monetary policies refer to the manipulations of interest rates and money supply to achieve various economic ends. The economic ends are similar in the sense that they entail full employment, economic growth, price stability, and a favorable balance of payment. This suggests that the fiscal policies and the monetary policies possess the same goals. In the regulation of the money in circulation, central bank adjusts the interest rate that entails the price of borrowing money. This paper keenly discusses fiscal and monetary policies theories and application. It is essential to note that the name fiscal refers to government’s actions at ensuring satisfying desired economic conditions in the country. In spite of the independence of the central bank, the government may collaborate with the central bank in designing policies that benefit the same goal. This means that it is, sometimes, impossible to have an economy without government control. In the history of economics, different schools of thought vouch for different policies. The fiscalists rely on the Keynesian school of thought in stabilizing the economy. This school of thought believes that fiscal policies are the only effective measure of instigating economic growth during a period of recession in a country. In turn, monetary policies are ineffective in stirring economic growth during a recession in a country. The fiscalists, unlike the monetarists, believe that the economy can never exist at full employment. The fiscalists believe that in order for economic growth to occur, the aggregate demand for goods must increase. The government, therefore, is in the most strategic position of affecting aggregate demand. In a large sense, Keynes is instrumental to the growth of economic thought because he engaged the demand side of economics in economic analysis. On the other hand, the monetarists believe that monetary policies are the only effective means of maintaining full employment in a country. This school of thought believes that the economy is always at full employment, and that supply creates its own demand. Since the economy is always at full employment, exercising a fiscal policy leads to the crowding out of investments. Over time, these two extreme schools of thought have been integrated to cultivate a comprehensive policy outlook at economic issues. Economists realized that fiscal policies best work during periods of depression while monetary policies work best when economies tends towards full employment equilibrium. Fiscal policy In their efforts to regulate spending and maintain taxation at an affordable level, governments emulates three types of fiscal policies. The first one is neutral fiscal policy. This type of policy is adopted when the economy is in equilibrium. One of the key aspects of neutral fiscal policy is that all the fund that the government uses to establish projects such as roads, factories, ports among others, is full obtained from tax revenue (Hansen 34). Another type of fiscal policy that government can use to achieve economic development is the expansionary fiscal policy. This entails a situation whereby government spending exceeds tax collected from the residents. This will mean that governments must look for donors to fund them so that they are able to maintain their economy at a competitive level. The policy must be looked keenly to make sure that funds borrowed from the donors are not diverted to other unplanned project .The third policy is contractionary fiscal policy. According to this policy, the economy of any country is slowed down when inflation is experienced and when it grows rapidly. This means that the government must raise taxes to control the inflation rate and to slow down the rate of spending by residents. The policies are applied in different areas for example; the neutral fiscal policy is applied in the U.S. to control the budget. The federal government controls how the money is shared according to the financial year and how they have planned for the budget. The budget must be gone through by the stake holders that include president and the congress. The two bodies must work together so as to come with a comprehensive report that is going to make life bearable to its citizens (Larch and Nogueira 46). The president makes sure that the proposed budget is passed to the congress so that they can decide how much money the government is going to spend on public needs. Such needs entail elements such as security and health care .On the other hand expansionary fiscal policy is commonly used by the federal government to make sure that their business problems are stabilized. Another application area in expansionary policy is the issue of unemployment to its citizens. The unemployed high number of people has to borrow money and return the same money with low interest. In contrast, contractionary fiscal policy is mainly used by the central bank or the finance ministry to make sure that the rapid economy growth of a country is put under control. This means that the government must come up with the measures to control it. The government has to increase the interest rates, the central bank then regulates the money their customers are going to deposit and the notes the other bank are going to hold. Monetary policy Monetary policy refers to the process by which the government through central bank regulates the money supply to its citizens with aim of controlling price fluctuations (Heyne 19). This means that the government must make sure that the prices of commodities are stable. The government must still ensure that the interest rates and exchanges rates are guarded fully against inflation. The central bank in corroboration with the government must come up with a condition that ensures that the citizens or government must start projects that would allow for increased output of goods and services in the country to make their economy worthwhile. This means that if the country is able to produce goods that the residents are going to use and remain with others for export purposes, the living standard of the people is going to improve greatly. The central bank, in cooperation with the government, must come up with a comprehensive policy. Such a policy ensures that the money is either contracted or expanded in the country .This is achieved when the central bank together with the government consult each other and come up with a comprehensive report that would make sure that the demand of money in the economy is estimated and the actual figures are attained. Types of monetary policies One of the key types of monetary policies is bank reserves. This policy requires the central bank and other banks in the country to hold certain amount of money in the reserve so that the supply of the money can be reduced thus creating equilibrium in the economy. Another type of monetary policy is the open market operation that ensures that government securities such as sale and purchase are open to everyone. The final type of monetary policy is federal funds rate. This is a type of policy that ensures that the funds must be achieved through the use of interest rates that would come from each bank charging each other, the loan is not a long term loan but a short term loan. The main area of application of monetary policies and specifically open market operation is in the banks. This is where banks have to come up with mortgage backed securities, this means that the banks have to pay for the sale and purchase of assets. Open market operation works because central bank has the mandate to bring money in and then reserve it for a period. The central bank is given the authority to contract money supply. On its part, reserved bank requirements as a monetary policy is applied to make sure that money is kept as a reserve in the bank to ensure that inflation does not occur. Lastly, federal funds rate are applied in trades balance where the money deposited to the central bank is held as federal reserves. This means that the money remains as a balance to the bank so that the supply is decreased and the country is able to stabilize its economy and improve the living standards of people Conclusion From the above discussion, it is quite clear that for any country to attain economic stability in the money supply as well as in the development of physical facilities; monetary and fiscal policies cannot be overlooked. In my opinion, governments must streamline the management of revenue collection authorities as a way of ensuring transparency and accountability in how the tax is collected and used. This should be done by ensuring that tax collection is done by use of an integrated system that is easy to control. In my opinion money supply and inflation should be effectively controlled by ensuring that government hires skilled economist in local banks as well in the central banks. I believe that inflation is instrumental towards maintaining stabilization in country. For instance, the central banks can maintain a favorable rate of inflation that deters unemployment and consequently stir economic growth. Works Cited Hansen, Bent. The economic theory of fiscal policy. New York: Routledge, 2003. Print. Heyne, Paul, Peter Boettke, and David Prychitko. The economic way of thinking. London: Prentice Hall, 2002. Print. Larch, Martin, and Nogueira Martins. Fiscal policy making in the european union – an assessment of current practice and challenges. New York: Routledge, 2009. Print. Read More