Monetary and Fiscal Policies - Example

Introduction: Gives an introduction to the different tools the government has and how it can use those tools to revive the economy and ensure growth Monetary Policies: Describes the different measures like interest rate, exchange rate and the mechanism of prices of assets to ensure that aggregate demand for economy strengthens Fiscal Policies: Describes the different measures like taxation, government spending and buying and selling of government bonds to look into the fact that aggregate demand strengthens and the economy grows. Policy to boost aggregate demand in UK: Shows the policy adopted by the UK and how a change in policy will help UK to come out of the global crisis Conclusion: Endorses how the monetary and fiscal policy helps to achieve aggregate demand and hence forth the growth rate predicted for the economy. Introduction Monetary and Fiscal policies are tools in the hands of the government to see that aggregate demand doesn’t fall. The government while forecasting the demand for the year looks into various factors and growth from different quarters. The expectations don’t always match and there are some deviations. These forces the government to use some immediate steps to continue on the path as forecasted. This makes the government use monetary and fiscal policies to see that growth is achieved. The effect on monetary and fiscal policy on the global crisis has been looked into for UK. It demonstrates how the monetary policies and the tools will help to bring down inflation and unemployment. The fiscal policy has also been looked into considering the long term effects and how it will help the UK government to ensure that different fiscal stimulus package acts for the consumers, firms and business units. Using this policies will benefit and will help to revive the economy. Aggregate Demand “Aggregate demand is total quantity of goods demanded in the economy at a particular price level and changes with the change in price”. (Mankiw, 2006) Aggregate demand depends on price. When price falls the quantity demanded increases. It shows that the demand is downward slopping. The government to ensure that demand does not fall use both the monetary and fiscal policy. Monetary Policies “The monetary policy adopted by the government brings about a change in demand”. Government uses these measures to see that the changes in demand are offset and the growth is ensured. Interest rate is a monetary measure which is used to see that aggregate demand doesn’t fall. Interest Rate Mechanism Government to ensure that demand rises “lower the interest rate which makes the cost of borrowing to be low thereby giving a push to investment and consumers spends more money making domestic demand for goods to rise and ensuring that investment and consumer spending grows”. (Sandra, 2005) This causes the price to falls and thus aggregate demand rises. Exchange Rate Mechanism Exchange rate which is also a monetary policy affects the aggregate demand. “The government to see that aggregate demand rises and doesn’t fall uses expansion monetary policy to ensure that the domestic currency becomes less attractive and depreciates giving a push to domestic goods making aggregate demand to rise”. (Sandra, 2005) Price of assets and stock mechanism The other way to ensure that monetary policies work is through the mechanism of prices of stocks and assets. Here, “lowering the interest rate makes government bonds a less viable option and people look to invest in stocks and securities and also easy availability of loans make people to invest in houses making the price of assets to rise up thereby giving a push to aggregate demand”. (Sandra, 2005) Fiscal Policies While using the fiscal policy the government uses government spending and taxation as the mechanism to control aggregate demand. “The most immediate effect of fiscal policy is that it affects the aggregate demand like supposes government increases spending by keeping taxes the same pushes aggregate demand or by reducing taxes it pushes aggregate demand”. (Well, 2008) The effect of fiscal policy on aggregate demand is explained further. Change in government spending A change in government spending is a fiscal measure which helps to improve demand. The government to “raise demand increases their spending keeping taxes the same “. (Mankiw, 2008) This gives people more money and the demand from the government pushes the demand thereby making companies to produce more. This makes the aggregate demand for goods to rise. Change in Taxation Another instrument in the hands of the government is taxation. The government to increase demand can “decrease the taxes which give more income in the hands of the consumer there by raising the money they have which makes aggregate demand to rise and due to the multiplier affect it rises the aggregate demand”. (Mankiw, 2008) Selling and buying government bonds Another tool which the government uses as a fiscal measure is borrowing by selling bonds or purchasing corporate bonds. “To increase demand government purchases back its bond or purchases corporate bonds from the market there by increasing liquidity which ensures that people have more disposable income which raises the demand for goods and gives a push to investment demand”. (Riley, 2006) This makes companies produce more and thereby raising the aggregate demand. Policy to boost aggregate demand in UK Using the monetary or fiscal policy thus depends on the circumstances an economy faces. This can be seen from the case of UK where the government has used the policy to come out of the recent financial crisis. “The recent financial crisis has affected the entire globe and UK has also been affected by it”. The government has used policies to bring the country out of the recent crisis but the effect has not been substantial. The UK government uses the policies depending on “production and employment and ensuring that there is a trade off between the long and short term goals”. (Mankiw, 2008) This has helped in determining which policy work best for the economy. The UK government had used “monetary policies and have cut down the interest rate and brought it down to 1% and the recent predictions shows it to further lower it to 0.5%”. (Bank of England, 2010) The use of monetary policy has not yielded the positives the government were looking to get from it. This will make “the government pump in more 150 billons in the economy”. (Bank of England, 2010) This has caused inflation level to rise. The monetary policy used by the government caused “inflation to rise up and the benefits that the economy received via monetary policies was wasted away”. (GEO Business, 2009) The monetary due to this was not able to get the benefit. It resulted “in the cost of living to rise and is followed by the decreasing in the value of currency which is further pushing inflation up”. (GEO Business, 2009) The rise in inflation and with the value of currency falling ‘the growth estimate for UK has come down to a flat growth or a negative growth of for the year 2010 which means the GDP will fall by 1.1 percent”. (UK Economy, 2010) The monetary policy thereby used is not giving positive results. It is also forecasted that “unemployment is going to rise by 8-10 percent and the economy coming out of recession might take a longer time”. (UK Economy, 2010) The government here needs to take immediate steps and look to draft policies and plans to ensure that the economy revives back. The UK government should further look to “reduce the interest rate so that it gives a push to consumer spending along with the fiscal measure to ensure that rise in inflation is negligible and it also controls unemployment as additional money will push investment thereby checking unemployment”. (ELNEP, 2008) A study conducted also reveals that “when expansion monetary policy is used the domestic currency depreciates for a period of time giving a push to aggregate demand which slowly returns to a gradual path after a certain time interval”. (Konuki, 2000) This makes it important to use fiscal polices along with it. The UK government should look forward to “borrow and invest in the long run but for immediate effect it should look to alter the tax structure”. (Bank of England, 2010) The government should look forward “for stable finance and by altering the tax structure the UK government can ensure that the fiscal policies yield better results”. (Bank of England, 2010) The UK government needs to take steps to “strengthen the financial markets by strengthening the rules so that transparency is ensured, prevent undue risk taking, and have safety capital adequacy as a buffer for all companies as it will help to bring stability and money thereby helping the economy to come out of the crisis”. (ENLEP, 2008) The government should look at public spending. This can be ensured by the government by taking “important infrastructure projects and projects which give more spending power to the customers”. (Spilimbergo, Symansky, Blanchard & Carlo, 2009) This fiscal measure will push for growth as government spending will help a direct influence on the growth. The UK Fiscal stimulus should be aimed at consumers. This can be done by seeing that “consumers have high wealth which can be done by lowering the tax thereby giving higher tax credits and unemployment benefits so that the marginal propensity to consume rises” (Spilimbergo, Symansky, Blanchard & Carlo, 2009) thereby pushing growth. The fiscal package for the firm should be “subsidies for production houses along with tax credit and measures to ensure long term loan so that the visibility for the high sector increases”. (Spilimbergo, Symansky, Blanchard & Carlo, 2009) This will give a push to growth and ensure that the trajectory of growth continues. Using the fiscal policy will also ensure that “the public debt which has risen to 42 percent is controlled from rising and also ensure that the policies look forward to the growth of the economy”. (Bank of England, 2010) Using the fiscal policy will also ensure that the interest rate are not reduced further and by doing so the government won’t have to pump more money in the economy. “This will help to increase the value of the currency and will help to control the inflation” (Bank of England, 2010) thereby ensuring growth. Conclusion Thus, we see that fiscal and monetary policies act as a tool to ensure growth. This will help to curb inflation and bring down unemployment. Thus, monetary and fiscal policies are tools in the hand of the government which helps to improve aggregate demand. The government uses this wisely depending on the circumstances and the results it gives help to alter the growth in the economy. Monetary and fiscal polices thus needs to be sued to ensure that both the short and long run are looked after. This will help to see that inflation is controlled and even employment improves. It is a common phenomenon for government to use these tools to see that the demand doesn’t fall and the economy is able to use it to ensure a growth trajectory. References Bank of England, 2010, “UK Monetary & Fiscal Policy”, Economy watch, retrieved on April 4, 2010 from http://www.economywatch.com/world_economy/united-kingdom/bank-of-england-monetary-fiscal-policy.html ENLEP, 2008, “Financial crisis threatens employment and growth”, retrieved on April 7, 2010 from http://www.elnep.org/html/245.htm GEO Business, 2009, “Monetary polices fail to control inflation”, retrieved on April 4, 2010 from http://www.geo.tv/4-18-2009/40082.htm Konuki T, 2000, “The effect of monetary and fiscal policy on aggregate demand in a small open economy”, Social Science Research Network, IMF Working Paper No 00/165 Mankiw Y, 2008, “The influence of monetary and fiscal policy on aggregated demand”, Short Run economic function Riley G, 2006, “Macroeconomics: Fiscal Policy effects”, Eton College, tutor2u.com Sandra T, 2005, “How does monetary policy impact the economy”, ONB Bank, Euro System Spilimbergo A, Symansky S, Blanchard O & Carlo C, 2009, “Fiscal Policy for the crisis”, retrieved on April 7, 2010, from http://www.voxeu.org/index.php?q=node/3055 UK Economy, 2010, “UK Economy Forecast”, retrieved on April 4, 2010 from http://www.economywatch.com/world_economy/united-kingdom/uk-economy-2010-forecast.html Well D, 2008, “Fiscal Policy”, The Concise Encyclopaedia of Economics, retrieved on April 4, 2010 from http://www.econlib.org/library/Enc/FiscalPolicy.html Read More