led by twodifferent organizations, are the ways that our economy is kept undercontrol. Both policies have their strengths and weaknesses, somesituations favoring use of both policies, but most of the time, onlyone is necessary. The monetary policy is the act of regulating the money supplyby the Federal Reserve Board of Governors, currently headed by AlanGreenspan. One of the main responsibilities of the Federal ReserveSystem is to regulate the money supply so as to keep production,prices, and employment stable. The “Fed” has three tools to manipulatethe money supply.
They are the reserve requirement, open marketoperations, and the discount rate. The most powerful tool available is the reserve requirement. The reserve requirement is the percentage of money that the bank isnot allowed to loan out. If it is lowered, banks are required to keepless money, and so more money is put out into circulation(theoretically). If it is raised, then banks may have to collect onsome loans to meet the new reserve requirement.
The tool known as open market operations influences money andcredit operations by buying and selling of government securities onthe open market. This is used to control overall money supply. If theFed believes there is not enough money in circulation, then they willbuy the securities from member banks. If the Fed believes there is toomuch money in the economy, they will sell the securities back to thebanks.
Because it is easier to make gradual changes in the supply ofmoney, open market operations are use more regularly than monetarypolicy. When member banks want to raise money, they can borrow fromFederal Reserve Banks. Just like other loans, there is an interestrate, or a discount rate, the third tool of the monetary policy. Ifthe discount rate is high, then fewer banks will be inclined toborrow, and if it is low, more banks will (theoretically) borrow fromthe reserve banks. The discount rate is not used as frequently as itwas in the past, but it does serve as an indicator to private bankersof the intentions of the Fed to constrict or enlarge the moneysupply. The monetary policy is a good way to influence the moneysupply, but it does have its weaknesses.
One weakness is that tightmoney policy works better that loose money policy. Tight money workson bringing money in to stop circulation, but for loose policy toreally work, people have to want loans and want to spend money. Another problem is monetary velocity. The number of times per year adollar changes hands for goods and services is completely independentof the money supply, and can sometimes contradict the efforts of theFed. The benefits of the monetary system are that it can be enactedimmediately with quick results.
There are no delays from congress. Second, the Fed uses partisan politics, and so has no ties to anypolitical party, but acts in the best interests of the U. S. Economy. The second way to influence the money supply lies in the handsof the government with the Fiscal Policy.
The fiscal policy consistsof two main tools. The changing of tax rates, and changing governmentspending. The main point of fiscal policy is to keep thesurplus/deficit swings in the economy to a minimum by reducinginflation and recession. A change in tax rates is usually implemented when inflation isunusually high, and there is a recession with high unemployment. Withhigh inflation, taxes are increased so people have less to spend, thusreducing demand and inflation.
During a recession with highunemployment, taxes are lowered to give more people money to spend andthus increasing demand for goods and services, and the economy beginsto revive. A change in government spending has a stronger effect on theeconomy than a change in tax rates. When the government decides tofight a recession it can spend a large amount of money on goods andservices, all of which is released into the economy. Despite the effectiveness of the Fiscal policy, it does havedrawbacks. The major problems are timing and politics.
It is hard topredict inflation and recession, and it can be a long period of timebefore the situation is even recognized. Because a tax cut can take ayear to really take effect, the economy could revive from therecession and the new unnecessary tax cut could cause inflation. Politics are another problem. Unlike the monetary policy runby the partisan Fed, the fiscal policy is initiated by the government,and so politics play a key role in the policy. When the concerns ofthe government are viewed, it becomes obvious that a balanced budgetis not the primary objective, anyway. The fiscal policy can also beused as a campaign tactic.
If tax cuts are initiated and governmentspending is increased, then the president is more likely to bere-elected, but has first to deal with the inflation his tacticcaused. Monetary and fiscal policies are what helps keep the nation’seconomy stable. With them it is possible to control demand forservices and goods and the ability to pay for them. It is possible tomanipulate the money in private hands without directly affectingthem.
The policies are simply a myriad of tools used to prevent a longperiod where there is high unemployment, inflation, and prices, alongwith low wages and investment.