Use of Fiscal and Monetary Policies to Stabilize EconomyIntroduction Governments adopt different methods to stabilize the economy during recession, with some of the major ones being fiscal and monetary policies. Factors that influence economy, such as changes in employment levels, demand for goods and services, as well as price stability, may fluctuate with time due to both internal and external forces. This will call for government interventions to bring about macroeconomic stabilization, using either or both fiscal and monetary policies. Fiscal policy refers to government policies on tax and expenditure aimed at increasing or decreasing aggregate demand through manipulation of government expenditures and taxation.
A government can stimulate economic growth and employment through an increase in government expenditure, decrease in taxes or other manipulations that affect aggregate demand in the move to stabilize the economy. On the other hand, economic stability of a nation may be influenced through monetary policy in which the central bank controls the levels of national output and price levels through variations in money supply. For example, an increase in money supply result in lower interest rates that stimulates private and public spending with direct positive impact on the economic growth.
In order to limit the growth rate in money supply, the central bank, or Federal Reserve must allow interest rates to increase to relatively high levels, making impossible to fix the amount of credit and costs independently. The fiscal and monetary policies are quite independent in that monetary policy falls under the central bank or Federal Reserve while the government controls fiscal policy to necessitate achievement of certain common goals. This paper seeks to expound on government’s application of fiscal and monetary programs in stabilizing the economy and effectiveness and limitations of these policies.
Use of Fiscal Policy to Stabilize EconomyThe fiscal policy approach of stabilizing the economy finds its roots in Keynesian economics school of thought, which supports the use of government spending and taxation to help even out economy. Keynes discovered this policy during the Great Depression in which he believed that forces of supply and demand remained too low in recessions as well as unemployment that translated to low spending among the people.
In such occasions, he suggested that government should intervene through increasing its spending to restore the economy to normal status. Governments have various ways of funding their spending including use of taxes and borrowing. Application of fiscal measures involves the nation’s annual budgets, which influences the total output and price level in the country. Governments may adopt several types of budgets such as balanced budget, deficit, and surplus budgets with diverse impacts on the country’s economy. A balanced budget has neutral effects on the economy because the government spending balance with the taxes and the total spending remain constant.
Therefore, such budgets lack any form of expansionary effects in the economy. In contrast, deficit budgets increase the price levels or total income depending on the status of employment in the economy. Adoption of deficit budgets compel the government to spend more than revenue from taxes, hence resulting to borrowing of funds to cater for the extra spending. On the other hand, Surplus budgets feature when the government spends less than the taxes received from consumers and businesses, which results in net decrease in aggregate expenditure.
This results in drag in the economic growth although the excess funds may play an important role in settling country’s national debt.