Fiscal And Monetary Policy And Their Importance For The Country - Essay Example

Fiscal And Monetary Policy And Their Importance For The Country Table of Contents Fiscal vs Monetary Policy This paper differentiates between fiscal and monetary policies, and applies both in the context of a country in recession, in this case Japan. As the US Federal Reserve System Board of Governors notes, monetary policy is within the realm of control of central banking systems, while fiscal policies that shape monetary policy are outside the control of the central banks, and are entirely in the hands of the legislative branches of government and of the executive branches, in this latter case Congress and the White House working together. The object of monetary policy is the stabilization of macroeconomic fundamentals, such as those relating to stable prices, stable growth rates for the economy, and the levels of employment and unemployment, with the ideal being full employment. In the United States, moreover, the existing mandate to the Federal Reserve Board emanating from Congress is for the former to promulgate fiscal policy decisions that will push employment numbers to the maximum as well as achieve stability in prices of goods and services (Board of Governors of the Federal Reserve System, 2014; Investopedia LLC, 2014l SparkNotes LLC, 2014). Separate from this general two-component mandate, however, the US Central Bank has autonomy with regard to the operational aspects of achieving those mandates, and that means that the US Federal Reserve Board has the independence to chart monetary policy without intervention from the US Congress. In contrast, when one talks about fiscal policy, one talks about things that relate to the way government raises revenues through taxation, in order to finance its activities in terms of government expenditures (Hipple, 2014); Investopedia LLC, 2014 (b); Powers, 2014). In contrast too, the Federal Reserve Board plays no role in the way fiscal policies are crafted and enabled. Those latter aspects of fiscal policy are entirely within the power of Congress and the White House, and excludes the central bank (Board of Governors of the Federal Reserve System, 2014; Krugman, 2012). In other countries as well, these distinctions between fiscal and monetary policies hold (Leigh and Stehn, 2009; Traclet, 2004). As the name implies monetary policy refers to the policy, as controlled bank, pertaining to the amount of money in circulation in the economy. The mechanisms of control of the monetary supply, or the effecting of monetary policy include tweaking interest rates for loans, as well as tweaking monetary reserve requirements for banks. The end result is that the central bank can calibrate the amount of money n circulation by controlling these monetary policy levers. In times of recession, mostly, the central bank will try to lower interest rates to spur borrowing and also relax controls on money to increase the overall supply of money in the economy. When an economy is growing to fast, it may overheat, and a side effect may be inflation that is out of control. In this latter case the tweaking of the monetary policy by the central bank is in the opposite direction from a recession, and that means increasing interest rates to discourage borrowing, and decreasing the amount of money in use in the economy by say upping the reserve requirements in banks (Powers; Hipple; Investopedia LLC, 2014). Apart from these common tools for monetary policy, the US Federal Reserve Board also makes use of the tool called “forward guidance”, which is a future direction guidance with regard to the interest rate and what the general public can expect moving forward (Board of Governors of the Federal Reserve System, 2014). With regard to fiscal policy, the levers are with regard to sourcing government revenues on the one hand, through taxation, and government spending, through the fiscal budgets. Where spending is greater than revenues, there are fiscal deficits, and fiscal surpluses where the reverse is true. In cases of recessions, the government can provide stimuli to the economy by increasing spending even at the cost of incurring deficits. Higher taxes, on the other hand, can be employed to put a brake on an economy and siphon off excess liquidity in an economy (Investopedia LLC, 2014; Hipple, 2014; Powers, 2014). The Japan Case In the case of Japan, the recent event is that of the country sliding into state of sustained economic contraction or a recession condition. The analyses and debates are on-going, and one key aspect of monetary policy that the Bank of Japan made use of in order to spur growth was the massive purchase of bonds. the general effect of hose massive bond purchases generally was to inject more money into the economy and effect a stimulus response, but this has not been enough for the country in terms of being able to avoid going into recession. On the other hand, a key aspect of the fiscal policy in Japan had been the increase in forward consumption taxes towards the end of last year, and the effect had been for the Japanese to push most spending towards the start of 2014, boosting GDP for the early part of the year but in effect also resulting in the Japanese generally putting a brake on spending for much of the rest of this year. This has exacerbated rather than eased problems related to negative economic growth (Mattich, 2014). On the other hand, the observation has been that the three pronged Abenomics approach of expanding the money supply as evidenced by the bond purchase, the increasing of the taxes on consumption in the long term, and the stimulation of growth in the economy also in the long term may work, even as the country had been able to pull out of a condition of general deflation of prices that has plagued the country in the last decade. So the prognosis is that these fiscal and monetary policy measures making up Abenomics will continue to work and should be supported. Abenomics can be regarded as being made up of both fiscal policy and monetary policy approaches to solving the country’s economic problems (Parker, 2014). On the other hand, there are criticisms of the way the government has addressed the problems plaguing the Japanese economy, and chief among these concerns is that the fiscal policy move to raise consumption taxes to raise prices has resulted in a massive slowdown in the economy, even though the opposite monetary policy tool of making more money available to the system through the massive injection of liquidity by the central bank was supposed to counter the effects of higher consumption taxes. The hope was that the raising of consumption taxes would spur inflation which had been too low, and negative over more than a decade, and deflation had not done the country any good in terms of spurring long term growth, spurring the growth of domestic industries, and overall improving the standing of the Japanese economy in the long term. The problem is that while government has spent massive amounts of money injecting liquidity into the economy through its bond purchases, the depressing effect of higher consumption taxes on the economy has been greater, and has outweighed fiscal policy measures around taxation. The result is that the economy still contracted and went into recession (Menton, 2014). References Board of Governors of the Federal Reserve System (2014). What is the difference between monetary policy and fiscal policy, and how are they related? FederalReserve.gov. Retrieved from http://www.federalreserve.gov/faqs/money_12855.htm Hipple, S. (2014). Fiscal Policy vs Monetary Policy. East Tennessee State University. Retrieved from http://faculty.etsu.edu/hipples/fpvsmp.htm Krugman, P. (2012). Monetary Versus Fiscal Policy, Revisited. The New York Times. Retrieved from http://krugman.blogs.nytimes.com/2012/09/01/monetary-versus-fiscal-policy-revisited/?_r=0 Investopedia LLC (2014). A Look at Fiscal and Monetary Policy. Investopedia. Retrieved from http://www.investopedia.com/articles/economics/12/fiscal-or-monetary-policy.asp Investopedia LLC (2014 (b)). What’s the difference between monetary policy and fiscal policy? Investopedia. Retrieved from http://www.investopedia.com/ask/answers/100314/whats-difference-between-monetary-policy-and-fiscal-policy.asp Leigh, D. and Stehn, S. (2009). Fiscal and Monetary Policy During Downturns: Evidence from the G7. IMF Working Paper. Retrieved from https://www.imf.org/external/pubs/ft/wp/2009/wp0950.pdf Mattich, A. (2014). Stimulus. Recession. What Europe Could Learn from Japan Now. WSJ. Retrieved from http://blogs.wsj.com/moneybeat/2014/11/17/stimulus-recession-what-europe-could-learn-from-japan-now/ Menton, J. (2014). Japan Recession 2014: What Went Wrong. IBTImes. Retrieved from http://www.ibtimes.com/japan-recession-2014-why-abenomics-isnt-working-1743270 Parker, C. (2014). Too Too early to judge Japan's economic strategy, Stanford economist says. Stanford News. Retrieved from http://news.stanford.edu/news/2014/november/japan-hoshi-economy-112514.html Powers, S. (2014). Explain the Difference Between Fiscal Policy & Monetary Policy. Chron. Retrieved from http://smallbusiness.chron.com/explain-difference-between-fiscal-policy-monetary-policy-3873.html SparkNotes LLC. Policy Debates: Effectiveness of Monetary Policy and Fiscal Policy. SparkNotes. Retrieved from http://www.sparknotes.com/economics/macro/policydebates/section1.rhtml Traclet, V. (2004). Monetary and Fiscal Policies in Canada: Some Interesting Principles for EMU? Bank of Canada Working Paper 2004-28. Retrieved from http://wwww.bankofcanada.canada.ca/wp-content/uploads/2010/02/wp04-28.pdf Read More