An overview of the importance of monetary and fiscal policy

The attitude of economists and government regarding the role of fiscal policy has radically changed owing to the Keynesian impact. The Keynesian analysis of fiscal policy is however, applicable to the advanced and well-to-do countries of Europe and it has little relevance to underdeveloped economies.

An overview of the importance of monetary and fiscal policy

Fiscal Policy Fiscal Policy refers to the use of the spending levels and tax rates to influence the economy. The governing bodies use combinations of both these policies to achieve the desired economic goals.

Fiscal Policy | Macroeconomic Analysis

Thus, the essential tools of fiscal policy are taxing and spending. But as the recession deepened into the Great Depression and no correction occurred, economists realized that a revision in theory would be necessary.

John Maynard Keynes developed Keynesian Theory, which called for government intervention to correct economic instability. At the same time, he recommended, it should decrease taxes in order to give households more disposable income with which they can buy more products.

Through both methods of fiscal policy, the increase in aggregate demand stimulates firms to increase production, hire workers, and increase household incomes to enable them to buy more.

What is 'Monetary Policy'

Keynes advocated the opposite positions during times of rapid inflation. It varies from country to country. The individuals who have control over the budget are referred to as the fiscal authority. In the United States, it is held by the executive and legislative branches; whereas in Europe, there are varied models with the power, mostly, lying in the hands of the prime minister or the finance minister and the parliament with the degree of power of either bodies changing through time.

Discretionary Fiscal Policy and Automatic Stabilizers The government exercises fiscal policy to prevent economic fluctuations from taking place. When actions are undertaken to minimize economic fluctuations, it is known as discretionary fiscal policy.

The Major Role of Monetary Policy in a Development Economy | Economics

Discretionary fiscal policy is employed when an increase in unemployment and inflation is observed. They are taxes and transfers that automatically change with changes in economic conditions in a way that dampens economic cycles.

For example, at times of economic downturns, the amount of money spent on food stamps automatically rises as more people apply for it or the rules are eased.

An overview of the importance of monetary and fiscal policy

The additional spending generated by the food stamps helps to soften the downturn for the individuals receiving the help, and also benefits the businesses and employees where the money is spent. The objective of expansionary fiscal policy is to reduce unemployment. However, it can also cause some inflation.

On the other hand, the objective of contractionary fiscal policy is to reduce inflation. However, it can also trigger some unemployment. By contrast, fiscal policy is often considered contractionary or tight if it reduces demand via lower spending.

Effects of Fiscal Policy The objectives of fiscal policy vary with duration and economy of application. In the short term, governments may focus on macroeconomic stabilization with aims of stimulating an ailing economy, combating rising inflation, or helping reduce external vulnerabilities.

In the longer term, the aim may be to foster sustainable growth or reduce poverty with actions on the supply side to improve infrastructure or education. Although these objectives are common among countries, their relative importance differs depending on the country circumstances.

In the short term, priorities may reflect the business cycle or response to a natural disaster while in the longer term; the catalysts can be development levels, demographics, or resource endowments.

Although they do have a negative effect on private investment, a varied effect on housing prices, lead to a quick fall in stock prices and depreciation of the real effective exchange rate.

Reduced taxes have the inverse outcomes as they have positive although lagged effects on GDP and private investment; have a positive effect on both housing and stock prices; and lead to appreciation of the real effective exchange rate.

However, putting them into practice is quite a difficult task because of various reasons. Thus, changes in expenditure generally must come from the small part of the budget that includes discretionary spending.

This gives the government less leeway for increasing or lowering spending. Another inhibiting factor is working with estimations. When lawmakers put fiscal policies in place, they base their decisions partly on the past behaviors of individuals.

Fiscal Policy and the Keynesian School

It is risky to assume that people will, for example, respond the same way to a tax cut in the future as they have in the past. Although changes in fiscal policy affect the economy, changes take time.Fiscal policy is a broad term used to refer to the tax and spending policies of the federal government.

Fiscal policy decisions are determined by the Congress and the Administration; the Federal Reserve plays no role in determining fiscal policy. 1 Fiscal Policy for Economic Development: An Overview BENEDICT CLEMENTS, SANJEEV GUPTA, AND GABRIELA INCHAUSTE Fiscal policy can foster growth and human development through a number of different channels.

These channels include the macro-economic (for example, through the influence of the budget deficit on. Fiscal Policy refers to the use of the spending levels and tax rates to influence the economy. It is the sister strategy to monetary policy which deals with the central bank’s influence over a nation’s money supply.

Monetary and Fiscal Policy Rules: An Overview of The Literature. In the recent monetary policy literature, monetary rules have received a large deal of attention, in particular following the work of Taylor (), (a).

The limitations and ineffectiveness of monetary policy in securing an accelerated rate of economic growth has further added to the importance of fiscal policy. Fiscal policy was designed to supplement monetary policy but now it seems to have supplanted monetary policy altogether.

Monetary policy: Actions of a central bank or other committees that determine the size and rate of growth of the money supply, which will affect interest rates.

Monetary Policy Definition | Investopedia