Thought Leadership

Monetary and Fiscal Policies

Monetary Policy

The Federal Reserve System is also known as the “the Fed”. The Federal Reserve System that was established in 1913 comprises twelve regional banks and a Federal Reserve Board. The Federal Reserve Board is empowered to regulate the circulation of currency in the U.S. economy. The Fed is in charge of the principal mechanisms for making monetary policies.

Policymakers at the Fed can stimulate economic activity by increasing the supply of money in case the economy is slow, not enough money is being invested to maintain economic growth or in cases where the unemployment rate is high. People are more likely to make purchases or investments if money is circulating in the economy thus generating business activity and jobs. If policymakers feel that the economy is causing too much inflation they can deliberately reduce the supply of money in order to slow down economic activity.

Fiscal policies

Throughout the depression, policymakers realized that changes in the amount the government spent and taxes it had collected could influence overall economic operations. Therefore, using fiscal policies was another way to manage the general condition of the economy. Reducing taxes puts money in the hands of the consumers, thus they can stimulate economic activity through increased purchases and investments. However, if the economy is overheating the government can raise taxes, thus taking money away from the consumers who would otherwise prefer spending.

Fed’s Policies

The Fed’s policies are often influenced by recent history. The inflation problems of the 1970’s and the 1980’s were still fresh in the minds of the policymakers. The U.S economy was finally pulling out of its long recession during 1993 and 1994 and most Americans were pleased to see the signs of recovery, nevertheless the Fed’s policymakers saw the signs differently.

The policymakers feared the return of inflation; therefore they began raising the interest rates in order to keep inflation in check. Those in favor of more rapid economic recovery however were critical of these policies and felt that higher interest rates would slow down investment and could stall economic growth

Money Supplies

Economists describe two types of money supplies--tight and loose.

Tight Money Supply

A tight money supply occurs wherein the amount of money that is circulating in the economy is low in relation to the demand for money by customers and investors; while the money supply is tight the interest rates tend to be high while the cost of most good and services is likely to fall.

Loose Money Supply

A loose money supply occurs when the amount of money is high in relation to the demand. In this case the rates of interest fall while the price of goods and services rise. Therefore, the supply of money circulating in the economy is attributed to a variety of related economic conditions such as inflation, deflation rise and fall of prices of goods and services etc.