Active Monetary and Fiscal Policy - Paper Example

Published: 2021-07-27
1071 words
4 pages
9 min to read
Carnegie Mellon University
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Governments rely on monetary policy and fiscal policy in influencing the macroeconomic outcomes. Monetary policy entails how money supply and interest rates are managed the central bank. In the stimulation of a faltering economy, the central bank reduces the interest rates which minimizes the expense of borrowing and then increases the money supply. The central bank can adopt the stringent monetary policy if there is the rapid growth of the economy by reducing the money in circulation in addition to increasing the interest rates. The fiscal policy establishes how the government earns and spends money. The government can reduce tax rates and increase its expenditure to boost the economy and also increases taxes and reduce its expenditure to cool an overheating economy (Mankiw, 2013). There has been a debate on the suitability of monetary policy or fiscal policy as an economic tool.

The advocates of monetary and fiscal policy perceive the inherent instability of the economy. They believe the institution of this policy can be used in the management of aggregate demand to deal with the inherent instability in the economy. The advocates of monetary and fiscal policy promote the use the policy in the stabilization of the economy. There is aggregate fall in demand when locals get pessimistic and can lead to the reduction in output and increase in unemployment rate. Policymakers can use the policy in reducing the effect of economic fluctuations. They can also take measures to improve the economy thereby ensuring full employment. In addition, they can help in the reduction of inflation and lower spending when there is excessive aggregate demand. The interest rates can be manipulated to control inflation. Inflation is experienced when general prices of products and services increases and the increment of the target interest rate can make investments more expensive and thereby reducing inflation (Mankiw, 2013).

The critics of monetary and fiscal policy explain that policymakers should not use the policy in the stabilization of the economy. The application of fiscal and monetary policy has some significant issues such as the time lag associated with the policy. The economic conditions are often dynamic with time and the implications of the policy such as the time lag can happen during the wrong time which might result in increasing instability of the economy. The critics, therefore, explain that the policymakers should not intervene to prevent further instability.

In my opinion, the monetary and fiscal policy tools are used in stabilizing economic growth by ensuring low inflation, stable prices of products and services and low unemployment rates. Despite the policy tools having their pros and cons, their effective application can be beneficial to the society and especially in the stimulation of demand after a crisis.

Increased Government Spending to Fight Recessions

The advocates of increased government expenditure to deal with recession points that it enables resources to reach the public mostly the low-income earners. It results in the improvement of consumption consequently fighting the recession. Another point claimed by the advocates is the multiplier effect which means that in case of more government expenditure other government sectors also benefit (Mankiw, 2013). The reason is that the concentration of resources in the public hands leads to the aggregate rise in the demands for goods and services. Industrial centers respond to the rise in demand, and this product helps in the growth of the economy ultimately suppressing recession. The traditional Keynesian analysis points that the increment of government purchases is a more appropriate tool to deal with the recession than reducing taxes. There are three kinds of government spending emphasized by policymakers. First, there is "shovel-ready" which entail public work projects which include repairs to public infrastructure. Second, there is federal aid accorded to the state and local government, and third, there are improved payments to the jobless through the institution of the unemployment insurance system.

Some critics oppose the move by the government to increase its expenditure to solve the problem of recession. They point out that increased government expenditure will consequently result in higher tax rates in future and anticipation will lead to reduced spending. Another effect of the increased government expenditure is the reduced profits in future and limitation of current investments (Mankiw, 2013). In case of the urgent increase in government spending, the government may buy products of minimal public value, and if it takes calculated steps, it may fail to improve the aggregate demand as expected.

In my opinion, the increment in government spending is appropriate when the economy is facing recession. The recession is experienced when an economy declines and results to the fall in the gross development product level. Low demand for products and services, increased unemployment rates and high poverty levels are experienced during the recession. It, therefore, means an influx of capital is essential to improve the economy towards recovery. This can only happen through the willingness of the government to spend more.

Reducing Federal Government's Discretionary Powers

The reduction of the discretionary powers of the Federal government is a policy applied by policymakers in ensuring there is a quicker response to events. Discretionary policies are mostly employed in the correction of economic crisis such as health care, federal aid, social security and military expenses among others (Mankiw, 2013). The proponents of discretionary powers point that rules should make monetary policy. Discretionary policy results into two issues namely it does not deal issues of incompetence and abuse of power and might to lead to more inflation than desirable. In dealing with these problems, the central bank can be forced to adhere to a monetary rule.

The critics propose the need for discretionary powers since they provide for flexibility and therefore the federal government can react appropriately to unforeseen events. The discretionary policy helps in the maintenance of rules and accountability and thereby avoiding misuse by central banks (Mankiw, 2013). It also allows for changes in the dynamic economic world.

In my opinion, the debate concerning monetary policy versus the discretionary policy is not healthy for an economy. Each day unpredictable events occur such as the failure of banks in the 1930s, the dramatic increases in the price of oil in the 1970s, and the drop in house prices between 2007 and 2009 among others. The presence of the discretionary policy helps in holding members accountable, and it allows the federal government to respond appropriately. I would, therefore, oppose the reduction of discretionary powers of the federal government.


Mankiw, N. (2013). Principles of macroeconomics (7th ed.). Stamford, CT: Cengage Learning.

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