Free «The Monetary and Fiscal Policy» Essay Sample

The Great Recession had serious effects in the global economy. Different governments applied different methods to stabilize the economy in their countries. There are two tools that governments use in regulating the economic activities during times of economic instability. The government can either use fiscal policy and monetary policy. In using the fiscal policy the government regulates the economy and expenditure through the taxes. The monetary policy is used through regulating the money supply, by influencing the interest rates. Both the fiscal and monetary have short term and long term effects. This paper will discuss the policies that were implemented by the USA Government and the effects the policies had both in the long term and short term.A recession is a period where there is a decline in the economy accompanied by a reduction in the Gross Domestic Product for a period exceeding six months, an increase in unemployment financial hardships experienced by most people. The US economy was in a recession from December 2007 to June 2009 (Isidore, 2008). The recent recession was experienced in many other regions in the world, thus adopting the name the Great Recession. The USA government employed fiscal and monetary policies as economic stimulus to boost the economy.When using the fiscal policy, the government regulates its expenditure by increasing or decreasing the rates of taxes and this is an intentional effort to aid in achievement of economic objectives of price stability hence influencing the aggregate levels in the economy. As suggested by Keynesian economics, increasing of government spending and decreasing tax rates are the best ways to stimulate aggregate demand. This method yields a multiplier effect. During the recession, the government stimulates aggregate demand in the economy by increasing government expenditure and reducing the tax rates. Thus there is more money to spend which helps in accelerating economic growth. The more the demand for consumer goods and services the more people will be employed, thus it helps in working towards full employment.

In a recession the government applies the expansionary rate which works by reducing interest rates as a way to stabilize the economy; it also plays a critical role in decreasing the country's net exports and hence resulting into the mitigating effect on the national output and income. This is attributed to the increased government borrowing which leads to increased interest rates which acts to attract capital from the foreign investors as the bonds offered by the country offers a higher rate of return. The government then acted against the recession by releasing money in the economy to reduce the out spinning levels of unemployment in the country. The interests rates are used to control the amount of money is in supply in the economy as it is used to control the amount of money that can be borrowed. When interest rates are increased, borrowings will be reduced while lower interest rate means more can be borrowed, and more money is released in the economy. More money in the economy means a higher expenditure and hence a higher economic growth. The monetary policy can be used by reducing the interest rates, increasing the amount of money in the economy, that is, monetary base and reducing the government reserves and releasing money in the economy.To get out of the Great recession, the US government used both the fiscal policy and the monetary policy, though the monetary policy was the main policy used. The fiscal policy takes time to be implemented and thus has a slower effect than the monetary policy. The USA government had tried to revive the economy at the onset of the recession through the fiscal policy by reducing the interest rates. The Federal interest rate was 1.5% in October 2008 down from 3.5% in January the same year (BBC News, 2008). As the recession had continued the governments option of lowering interests further was limited and the government opted to use its reserves which were created by several legislations and funds stimuli. One of the ways the US government used to end the Great Recession was a stimulus plan that was intended to improve the unemployment situation, promote investment by rebuilding on investors confidence and improve on consumer spending. The government did this by releasing funds which were used in bailing out the investment institutions. The federal government through Treasury released $50 billion was to be used to insure the money market funds. This removed the fear which had led to investors withdrawing from the money funds. The increase in withdrawals from money funds had resulted to serious economic problems for there are many businesses that use money funds as their source of business funding. The $50 billion was released from the Exchange Stabilization Fund. In addition to this the Federal Reserve helped in bailing out the banks through $230 billion which was released to the banks to secure the banks' illiquid asset-backed holdings (Gullapalli & Anand, 2008). In releasing money to the banks, it would mean that the banks would resume lending money which would assist in stabilizing the economy. The banks would release the cash which would in turn help regain investor confidence. The end result was loosening the credit situation. Loosening the credit situation in an economy would mean more money in the market, increased consumer expenditure and economy growth.

The monetary policy includes releasing money in the economy to improve on expenditure. This is based on the Keynesian theory that government deficits should be utilized in bridging the gap in consumer spending that occurs during a recession. One of the areas that were affected by the recession was investors' confidence especially in the mortgage assets. This had created panic in the investment industries and especially after the collapse of some investment institutions such as the Lehman Brothers. The government decided to save those institutions that were thought to be of benefit to the public especially in the long run. The bailout plan by the government was meant to help improve the economy. In releasing funds the government helped in creating confidence in the bank, investors and consumers. The regained confidence would mean that the investors would continue investing which would increase savings which in turn would lead to available funds for borrowing by businesses. Business growth would contribute to the economic growth. The investment from foreign countries increase capital inflows into the country increasing the demand for the country currency hence the consequential appreciation of the currency. Such appreciation ensures that the locally produced goods costs more to foreigners than before and imported goods become cheaper than before the implementation of the policy therefore decreasing the country's exports as it increases the level of imports and such condition acts to reduces the effects of recession on the country's economy.In order to control the effects on the mortgage crisis, the Securities and Exchange Commission stopped selling of 799 financial stocks and also illegalized the selling of naked short selling (Ellis, 2008). One of the measures that the US Federal Governments undertook was to reduce the interest rates from 2% to 1.5% (BBC News, 2008). In addition to this the Government had spent $700 billion to bail out businesses that were near collapse, (BBC News, 2008). By the end of 2008, there were proposals for Legislation to allow the federal government to bail out the mortgaged asset industry in a relief program named the Troubled Asset Relief Program (TARP). The first bill, HR142 was passed in October 2008. The Act was to provide relief to the type of assets that were troubled. The Act, popularly known as The Emergency Economic Stabilization Act of 2008 was meant to allow for release of $700 billion bailing out troubled securities and especially the mortgage related assets. The Act has three divisions, the Energy Improvement and Extension Act that allowed tax credits for electric vehicles; the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 which offered $100 billion tax relief for businesses; and the Paul Wellstone and Pete Domenici Mental Health Parity and Addiction Equity Act of 2008 which required insurance companies to cover mental health as well as for substance abuse.

Another Act, the American Recovery and Reinvestment Act, was signed in February 2009. The Act included several stimulus packages, at a nominal value of $787 billion that would help in reviving the economy. The stimulus would be inform of monetary policies to assist in federal tax incentives, boost the unemployment benefits, government spending in education, health, infrastructure and the energy sector. The stimulus would assist in saving loss of more jobs, thus reducing the negative effects of unemployment.Short term consequences for the bail out Act include the fact that the act resulted to an increase in public debt which went up to US$11.3 trillion. The short term cost of the relief TARP, had been estimated at $341 billion but this has been the case as the cost has been estimated to have fallen to approximately $50 billion thus the stimulus would only cost about 1%. Even the stimulus has been successful with institutions like AIG; the government will be making a few short term losses. An estimated loss of $17 billion is expected from the stimulus spent on the motor industry (Gross, 2010).The long term effect of the monetary policy application in recession times is that it affects the rate of inflation. As a result of releasing money to the economy, consumer expenditure increases. If not controlled, this leads to too much money in the market and thus the rate of inflation increases. A high inflation rate reduces economic growth.The Recovery Act was successful in the short term, the US GDP increased and the rate of unemployment rate went down. However there are predictions that there will be long-term negative effects resulting from the Act. The positive impacts are expected to be reducing by the fourth quarter of 2010 reducing the output level as compared to the input (Armbruster, 2010).One of the negative effects of the stimulus program was the fact is that the action was received negatively by some who saw it as a way of strong and financially stable private companies being 'forced' to help out on financially weak companies. Since the bail out would only be short term, there would be possibilities that they would fail again which means public money would have been wasted in saving institutions that were not worth saving. Questions have been raised on the future survival of the institutions that were bailed out. The bailout also created unfair competition between the bailed out companies and the institutions that were not bailed out and especially with the small companies. The big companies had a fair advantage over their small or medium sized competitors. In addition to this, the funds used in the bail out plan may affect the economy in the long term through creating a government deficit, affecting the interest rate spread and increasing government debt (Aardt & Naidoo, 2010). Monetary policies that use stimulus also have negative effects of distorting the market dynamics which have negative effects in the long term of disrupting economic growth.


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