Expansionary Economic Policy - Example

Expansionary Economic Policy Introduction with thesis ment The recession that stemmed in The United s in December 2007 was the longest global economic recession after the great Depression. The United States was severely impacted by the recession. In response, the Federal Government implemented a number of monetary and fiscal policies to get the country out of recession and to negate the damaging impacts of the recession. The fiscal policy is a famous government policy option used to even out the economy. The fiscal policies include the plan of the federal government to smooth out the economy by using these policies to improve the aggregate demand and to drain the economy through the use of taxation. The government uses fiscal and monetary policies to ensure strong growth and sustainability of the economy as well as reduce poverty. The economic crisis negatively impacted the economies across the globe by affecting investment levels, private consumption and international trade all of which resulted in lowering the gross domestic products (GDPs) of different countries. The fiscal and monetary policies of the Federal Government were aimed at achieving two major objectives including the improvement of the weakening financial structure and the control of the increasing economic recession. This thesis is aimed at discussing and evaluating the expansionary monetary policies and expansionary fiscal policies implemented by the Federal Government and their impact on the money supply, GDP, interest rates, aggregate demand, spending, and money supply in an economy. Discussion Expansionary Fiscal Policy The Federal government uses three main tools of fiscal policy in order to control the economy. These tools of fiscal policy are taxes, government spending and transfer payments. When the taxes are increased or decreased The underlying thinking of the Federal Governments and economists is that recession and inflation are opposite terms for one another. During a recessionary period, the circulation of money in the economy is less. Therefore, the government responds by trying to inject more money into the economy. The Federal Government responded to the financial crisis by the fiscal stimulus of cutting down on the taxes. Generally, the Federal government uses taxes to control the volume of goods and services that are bought by the public. The decrease in taxes resulted in a decrease in the expenditure levels of the general public. The decreasing of taxes would cause an increase in the demand levels because the consumers would be able to buy the products. This would reduce the imbalance between demand and supply in the economy. Thus, the expenditure levels would increase. This would also increase the level of production in the economy and the employment levels in the economy which would result in creating a balanced economy. Both the tax policies and boosting of aggregate demand are effective policies used to balance the economy. Keynesian economics indicates that the use of the government funds by the implementation of tax and expenditure policies are important fiscal policies that stimulate the level of economic activities in a country (Taylor, 2009). The decrease in the tax rates would increase the collection by the government. When the government spending are increased or decreased Increasing the government spending is an important fiscal policy tool used to inject money into the economy. Recession is characterized by job losses thereby increasing unemployment, homelessness and insecurity. These can be removed by the policies of the government used to ensure the smooth flow of money in the economy and the creation of employment opportunities. The spending of the Government done towards labor intensive projects helps to create employment opportunities and benefit the businesses and the community, thereby helping the economy to fight recession. The government spending may be done in the areas of education, construction, power generation, communication network and other large scale infrastructure projects. This would help in improving the flow of investment into the economy. Aggregate demands refer to the total demands existing in the economy encompassing the demands of the businesses, consumers and the government in various levels of price. According to Keynesian economics, in the recessionary periods the aggregate demand needs to be stimulated or increased by the policies implemented by the government. Aggregate demand can be increased by cutting done on taxes and government spending. The government spending and tax cutting are the automatic stabilizers or non-discretionary fiscal policies used by the Federal Government to combat the negative effects of recession. When the transfer payments are increased or decreased Transfer payments are fiscal policy tools which tend to create a buffer for the individuals in order to insulate them from the negative impacts and shocks created by the recession on the economy of the country. The transfer payments help to insulate the individuals and households from the negative effects of the recessionary period. During recessionary period, the income of the households and individuals decrease to a large extent. When income reduces, the numbers of people who are eligible for the income supplements also increase. Therefore, transfer payments help to reduce the effect of the recession in decreasing the gross domestic product ((GDP) and to reduce the effect of the decrease in real GDP on the individual disposable income levels. The income taxes imposed by the Federal Government have similar effects. When the income levels decrease during a recession, the general public pays lesser amount as income taxes. The transfer payments, thus acts as an automatic stabilizer on the economy which reduces the fluctuation in the gross domestic product (GDP) i.e. increases the GDP when it decreases and reduces the GDP when it is increasing (Auerbach, 2009). The transfer payments also have the effect of controlling the GDP to fall as much as it would have fallen in case transfer payment was not implemented. Expansionary Monetary Policy The three instruments the Federal Reserve Bank (The Fed) uses while dealing with monetary policy are the discount rate, open market operations and the required reserve ratio. These rates do create a lot of changes in the economic condition of the country and does affect the way the bank and the depository institutions perform. These all factors do affect the spending and the flow of money in the country. When the required reserve ratio is increased or decreased The depository institutions and the banks need to hold a portion of their deposit as reserve in the Federal Government. They can hold reserves in the Federal Government in the form of vault cash or in the form of deposits. These reserve requirements are the amount of fund that the depository institution or the banks need to deposit in any form as a security against the fixed deposits from the federal bank. Depository institutions can keep assets in the form of liquid cash or deposits with Federal Reserve Banks. The board of the Governors have the sole right to make the changes in the reserve rates which are been made specified by a certain law. The reserve rate is been changed very rarely but he changes have a lot of potential to bring a huge difference in the economic condition (Delong, Summers, Feldstein and Ramey, 2012). The Federal Government decreases the reserve rate ratio to increase the supply of money as the banks need to lend more in this case. On the other hand the ratio is been increased to reduce the supply of money as the bank needs to lend less in this case compare to the decrease in reserve rate ration. When the discount rate is increased or decreased The discount rate is basically the interest rate that the commercial banks are been charged by the federal bank. It is charged to those commercial banks that try to take more additional reserves from the Federal Government. This interest rate is been given to the eligible commercial banks to reduce the liquidity problems and also the pressures for keeping the reserves. This discount rate allows the federal bank to have a good control over the supply of money and also helps the federal bank to bring a financial stability in the market. To increase the supply of money in the economy the federal bank reduces the discount rates to make it cheaper for the commercial banks so that they need to deposit a narrow amount of money. On the other hand to reduce the flow of money in the market the federal bank looks to increase the discount rates so that the commercial banks need to have more money as the deposit for the reserves. The funds borrowed from the Federal Reserve Bank is been analyzed based on the discount rate been given and it is been reviewed after every 14 days. Buying or selling of securities to deal with expansionary monetary policy The buying or selling of governmental securities refers to the open market operations in the monetary policy. These do help in controlling of the bank reserves, the interest rates and also the money supply in the market for the federal bank. Federal open market committee does control the monetary policy and also implements the domestic trading desk of New York Federal Reserve Bank, because the open market operations are flexible, quite effective and also easily implemented. When federal bank buys the issued securities from the large banks and also from the securities dealers, it increases the money supply in the market and on the other hand when federal bank sells the securities the money supply in the market decreases in a huge way. The flow of money supply does change with the buy and selling of the securities by the federal bank. Federal bank generally buys and sells the securities from the large commercial banks and security agents (Reynolds, 2003). These factors do affect the money supply, spending, aggregate demand, employment, interest rates, GDP of the country in a huge way. With the increase in the reverse rate ratio there would be less loans been given and the overall supply of the money will go down in a huge way. This will lead to huge deflation. This will lead to less economic growth and less boom in the economic condition. Because of the increase in the reserve ratio the interest rates increases as a result of which the spending of the public reduces to a great extent. With the reduction in the spending of customers the aggregate demand of the commodities reduces as a result of which the GDP of the country goes down. With the reduction in the demand the supply will increase as a result of which the price of the commodities will go down in a huge way and their will be less production as a result the employability rate of people will go down in a huge way. In a whole it will affect the overall economy of the country. Conclusion Looking at this study it can be seen how the various tools of fiscal policy and monetary policy affects the overall economic condition of the country. Federal bank makes the use of these tools to keep the economic condition stable in the country and have a good balance in the money flow in the market. When there is excess liquidity in the market it is one of the major responsibilities Federal Government to take a note of the situation and take its action likewise. Firstly it can make the necessary changes in the taxation rates and spending of the governments. Such kind of actions seems to have a detrimental effect on the economy and likewise the growth curve will find its way along the expansion path. If the federal government takes the initiatives to increase the level of taxation it can be assumed that the aggregate demand along with the GDP of the country is more likely to get affected. Contraction of money supply will lead to less money on the hands of the people and accordingly they are going to demand less than their expectations. In this fashion the gap between supply and demand will be created in the market and following the rules of the market the level of employment will take a downward sloping curve. References Auerbach, A. J. (2009). Implementing the New Fiscal Policy Activism. American Economic Review. Vol. 14(1), pp. 1671-1672. Delong, J, Summers, L, Feldstein, M and Ramey, A. (2012). Fiscal Policy in a Depressed Economy. Brookings Papers on Economic Activity. Brookings Institution’s. Vol. 1 (1). Reynolds, A. (2003). CRISES AND RECOVERIES: MULTINATIONAL FAILURES AND NATIONAL SUCCESSES. Cato Journal. Cato Institute. Vol. 23(1). Taylor, J. B. (2009). The Lack of an Empirical Rationale for a Revival of Discretionary Fiscal Policy. American Economic Review. Vol. 99(1), pp. 550–555. Read More