The U.S. Fiscal and Monetary Policy - Essay Example

U.S. Fiscal and Monetary Policy The United managed more or less to run into the fiscal cliff, however, there isstill a dreadful lot of fiscal tightening planned for 2013. The tax agreement struck to begin the year extended majority of the Bush tax cuts and derailed the sequester, but the motivating payroll tax cut was left to expire, and is now having an immense effect on the paychecks (Haas and Richard 83). The derailed sequestration, which was planned to start in March, would cost the economy some considerable percentage in 2013. The question remains, should the United State be concerned of the quick pace of fiscal consolidation? First, this is not the best way to handle fiscal policy. America’s approach has been to attempt and fall short of accomplishing budget deals, then intimidate itself with clunky regular cuts if it can reach a deal, then let most of the automatic cuts to happen in lieu of a deal. The fact is, not many of the Americans agree that this ought to happen to the budget. The Americans are wary of attempts to restrain health-cost growth, tax reforms and public investment among others, a worry that appears well grounded. Rather, the path of least political disagreement is an everyday order. Sequestration also known as sequester is a process that cuts the federal budget in most agencies and departments automatically. The Congress introduced the threat of sequestration in the Budget Control Act of 2011 with an aim of encouraging compromise on debt decreasing efforts. Way back in 1974, the Congress came up with a budget process that gave it all the powers it required to control spending. In 2011, things changed leading to the sequestration which was as a result of disagreement in the Congress on the best way to decrease deficit. In 2010, the Republicans acquired a majority in the House of Representatives following support from the tea party movement. Nevertheless, Democrats are in charge of the Senate and Presidency (Thompson and Samuel 90). Thus, the Republicans could not get support for their budget, and abandoned the budget process. Instead of either approving a new budget, endorse the current resolution to finance the government at the present levels or increase the debt ceiling, they put America’s first -ever debt deficit in risk. President Barack Obama’s administration thought by effecting cuts in social programs and reducing military spending, the Republicans would concur to revenue boosts. Regrettably, it worked the other way around. The military hawks within the Republican Party were less as compared to the Tea Party –backed fiscal hawks. It was not a surprise when the Party declined to budge or withdraw sequestration. Additionally, the Republicans are very responsible for what took place (Haas and Richard 203). To this day, they are the influential outspoken Americans and owners of Wall Street banks and massive companies while the Republican Party is obviously under the control of the most extreme right wing forces, which resulted in the party’s approval ratings to drop to 29%. Come 29th Jan 2010, the American President spoke to the House Republican representatives and asserted that “the main drive of their long-term liabilities, which is known to everyone, is Medicare and Medicaid or rather health care spending and nothing comes above this priority.” During the summer of 2011, while trying to negotiate a “Grand Bargain” with Boehner (Speaker), President Obama suggested his support towards increasing eligibility age for Medicare as well as the cost of living formula for Social Security, which would decrease the monthly earnings of seniors. The three major Democrats in the House of Representatives-James Clyburn, Nancy Pelosi and Steeny Hoyer deliberated on the need to cut earned revenue benefits. In August 2011, the two parties teamed up in passing the Budget Control Act, which contained sequestration. This bill offered an establishment of the “Super Committee” of six Democrats from both sides and charged them with creating a plan to cut the deficit by $1.2 trillion for next 10 years. The six Democrats made it known they were cutting for “entitlement” as long as they were matching up improvements in revenue. The “Super Committee” therefore failed to come to an agreement hence sequestration while the members of the Congress who voted for the Budget Control Act that caused this incident were equally responsible. There was also a key challenge faced by supporters of NO CUTS, NO COMPROMISE and NO CONCESSION in terms of Social Security, Medicare, and Medicaid in addition to other social programs. By 27th March 2013, the Congress was expected to act on an ongoing resolution to have the government functioning for the remaining part of the fiscal year. This similar spat, charges and counter charges filled the airwaves by politicians from the main parties would not end here. There arose major differences between the parties on the question of dealing with the shortfalls- what if the Republicans caved in and accepted the added revenue. President repetitively asserted he was in favor of the major cuts in “entitlement” even if it meant being on the liberal wing of his party (Thompson and Samuel180). According to Senate Majority Whip Dick Durbin the sequestration and government shutdown of October 2013 is “the single biggest sticking point” in deliberations, while his opposite member in leadership, Sen. Chuck Schumer considered it a central disagreement. Further, Schumer said the parties have perspectives about sequestration. For instance, Sen. Chuck Schumer and his party had passed a budget of $1.058 trillion, however, only was passed (the Ryan budget-at $988 billion) and that was a very serious issue. Democrats’ remained stable, upright and intact about sequestration was a pleasant surprise for some progressive members who were bothered leadership would give up in this area. Nevertheless, they were encouraged following the polling that showed them control in budget fights. Democrats further noted that they were worried about the harshness of the cuts. According to the Senate Republican plan created by Sen. Susan Collins, the state would have received funds of $988 billion for the following six months (Grey and George 87). Majority of the Senate Democrats confirmed they would put up with that number although it did not last for long. For instance, Sen. Tom Harkin felt if they could have a short-term or an ongoing resolution at $988 billion to put them through at least until December. Another question posed by Sen. Angus King was if they are locked into the number amounting to the following year, or were they going to get at a point where there are budget deliberations that can work with the same number. The worry for Harkin and King and the likes was that the party could forfeit a lot of deliberation power by signing off on Collin’s plan. In the Budget Control Act, yearly spending would decrease to $967 billion on 15th respectful of the budget during that time (Grey and George 211). However, the democrats were not in favor of that. According to them, that was going to be a mistake meant to put off, prompting moments such as a budget deal ending for the six months negotiations. Taking time on this matter would dis-incentivize the deliberations by putting the Democrats on a weaker ground. Also, if the will of the Speaker Boehner and Sen. Republicans, of passing both the debt limit and clean CR increase, there could have been a conviction within the Senate Democratic caucus that there is completely no way they would have any in future negotiations concerning this, that would be in a better situation. Fiscal Policy Fiscal policy is one of the major methods used by the government to influence the general economic performance in America. There are two kinds of fiscal policy- expansionary and contractionary policy. Both of them engage the use of the government’s budget and its capability to levy taxes. It should be worth noting that the effects of sequestration are almost certain after agencies start to lay off staff, which needs a one- month notice. In case more delays happen at border crossings, airports and food factories that lack enough supervisors, the ripple effects could lead to a stunted economy as well as hurt employments in addition to profits more than it has been estimated. The Wall Street seems to have ignored such possibilities. In the context of the fiscal type used the government to enact sequestration / shutdown, we examine both expansionary and contractionary fiscal policy. Expansionary Fiscal Policy This fiscal policy is implemented through controlled government spending, decreased taxes or a combination of both. It’s mainly used to increase aggregate demand for products in the economy as well as reduce unemployment. By bolstering its own acquisition of goods and services, the government attempts to stimulate the economy. Apart from the October 2013 shutdown, the government since the 1930s used expansionary fiscal policy to fight the outcomes of the Great Depression. This fiscal policy has a multiplier effect, whereby every dollar used by the state generates more demand within the economy. According to Gregory Mankiw, the former White House and Harvard economist, if the Defense Department orders for more parts and equipments from a defense contractor, the purchases will raise production and job opportunities for the contractor. The firm’s workers boost their expenditure on consumer goods, demonstrating the multiplier effects resulting from fiscal expansion. Contractionary Fiscal Policy When policy makers in the government cut spending or add taxes, they are involved in the contractionary fiscal policy. Governments might endorse contractionary measures to derail economic expansion as well as prevent inflation. Further, they might endorse the policy for ideological purposes (Langdana 166). Such include decreasing the general size and scope of government acts or decreasing budget debts, whereby the government uses more money than it makes. The economics department at Harper College asserts contractionary policy decreases demand within the economy while lowering inflation. It can also lead to higher cases of unemployment. For instance, the economic fluctuations autonomous of policy deeds by government frequently affect the level of tax revenues, pushing elected representatives to change fiscal policy. It is obvious economic recession decreases output and employment, leading to diminished revenue for state coffers. This repeatedly forces policy makers to deem contractionary measures as appropriate and thus may increase taxes or cut government expenditures. In theory, higher government expenses will cause a rise in the aggregate demand and lead to a better economic expansion (AD= C+1+G+X-M). Lower taxes should be resourceful in improving disposable earnings of consumers so the outcome is higher consumer spending. Further, this should raise the aggregate demand and might as well lead to an improved economic growth. Expansion Fiscal policy might also cause inflation resulting from higher demands within the economy. Open Market Operations (OMOs) Open market operations, also known as OMOs are Federal Reserve’s most flexible and commonly used method of executing American monetary policy. Open market operation is a significant type of monetary policy tool that involves the buying and selling of government securities on the markets particularly by central banks (Grey 64). In America, the Federal Reserve Bank of New York carries out open market operations. Because the Central Bank needs to expand the supply of money, it buys securities from other banks, increasing their reserves as payments. This then leads to more reserves than the banks want. Therefore, it is free to lend such funds. To decrease the funds, the Federal Reserve put the government securities up for sale to banks and gets reserves as payments, which then decreases the reserves held by these banks. OMOs are one of the three main tools implemented by the Federal Reserve to accomplish its monetary policy objectives. The others are altering terms and conditions for borrowing at the discount window and regulating reserve prerequisite ratios. The implementation of OMOs in the “open market” also called secondary market for securities purchase is the Federal Reserve’s easiest means of implementing its aims. By changing the level of reserve balances in the banking system through OMOs, the Fed is in a position to counteract or support stable, seasonal or recurring shifts in the supply of reserve arrears and therefore affect short-term interest rates and other interest rates by extension (Grey 140). In most if not all cases, the Federal Reserve carries out open market operations with primary dealers – state securities dealers with an establish operating relationship. Therefore, while the target policy rate is the uncollateralized loaning rate among banks (fed funds), the Fed functions in the collateralized loaning market with the main dealers (repo). This is possible since the main dealers have accounts at the clearing banks, which are also depository institutions. Thus, the Fed transacts from the dealer’s account at the clearing bank, this can be an advantage or disadvantage to the banking system. Maybe the Fed funds rate is the most common Federal Reserve tool. In case a bank does not have sufficient at hand as required by the reserve, it can borrow from other banks. The federal fund rate is the normal interest banks charge one another for overnight loans. The amount given and borrowed is called Fed funds. The Federal Open Market Committee is responsible for targeting certain levels for Fed funds at its frequent meetings. The Fed is currently using the Federal funds rate to manage the interest rate banks do for loans and deposits. Banks would wish to lend every dollar under their custody but the Federal Reserve permission to keep a specific percentage. The Federal Reserve, through (FOCM) targets a certain level for the Fed funds rates. It utilizes the OMOs to push the Fed funds rate towards it targets. In case it wants lower rates, Fed buys securities from its banks then deposits credit onto the bank’s balance sheets, allowing them more reserves than needed. Thus the banks have to decrease the Fed fund rate to lend out the surplus funds within one another (Haass and Richard 37). In case the Fed requires higher rates, it does the exact opposite. It trades of its securities to banks, doing away with funds from their balance sheets, giving them limited reserves hence letting them to increase their rates. Conclusion According to the economic policy-makers, there are two types of tools that influence a nation’s economy-fiscal and monetary. Fiscal is concerned with government’s revenue collection as well as spending. For instance, when the demand is low in an economy, the government can intervene and improve its spending to encourage demand. Alternatively, it can lower taxes to raise disposable earnings for citizens and companies/firms. On the other hand, monetary policy involves money supply, which is controllable through factors such as interest rates and reserve requirements in banks (Langdana and Farrokh 100). For instance, to have power over high inflation, policy makers who are mostly central banks can increase interest rates hence decreasing money supply. Both methods are relevant in a market economy, although not in socialist, communist or fascist economies. Noteworthy effort by the American government to settle on a combination of fiscal and monetary policies for sustainable development and stable prices is unmistakable after the Great Depression of the 1930s. It has not been an easy task as characterized by a number of disappointments along the way. Word Count 2527 Works Cited Grey, George B. Federal Reserve System: Background, Analyses and Bibliography. Huntington, NY: Nova Science Publ, 2009. Print. Haass, Richard. Foreign Policy Begins at Home: The Case for Putting Americas House in Order. , 2014. Print Langdana, Farrokh K. Macroeconomic Policy: Demystifying Monetary and Fiscal Policy. New York: Springer, 2009. Internet resource. Thompson, Samuel C. Citizens Guide to U.s. Economic Growth and the Bush-Kerry Economic Debate. New York: iUniverse, 2011. Print. Read More