UNIT 7+12: FISCAL POLICY AND MONETARY POLICY
FISCAL POLICY
DEFINITION
Passage: a government policy related to taxation and public spending
GOAL
To maintain
Economic growth
High employment
Low inflation
TOOLS
Government spending
Increases spending -> Create jobs -> Create icome -> People spend more on purchases ->
economic growth
Taxation
Increases taxes -> Less income -> Purchase fewer goods -> Economy tend to shrink
2 TYPES OF FISCAL POLICY
Expansionary policy
Conditions for the occurrence
Economy is not growing fast enough
Unemployment is too high
Aim
Stimulating total spending in the economy, known as aggregate
Method
Increasing spending
Cutting taxes
Result
Increase purchase -> Raise demand -> Create jobs -> Generate more spending ->
Higher employment and a growing economy
Contractionary policy
Conditions for the occurrence
Inflation is high
Aim
Restrict demand and slow down the economy
Method
Reducing public spending
Increasing taxes
Result
Reduce the amount of money for purchasing -> Decrease spending and demand ->
put pressure on prices and slow down the economy
FACTORS
Inside factors
The level of economic growth likely in the future
The level of unemployment likely in the future
Whether or not to run a budget deficit
Political considerations
Outside factors
The fiscal policies of other countries
The requirements of the International Monetary Fun (IMF)
DEFICIT SPENDING
Definition
A situation in which a government's spending is greater than the money it receives in
taxes, etc...
Is spending funds obtained by borrowing or printing instead of taxation
Helpfulness and Harm
Helpfulness
When: Unemployment is high
Influence: Help the government undertake projects that use workers who would
otherwise be idle
Result: More money is being pumped into the economy, it will then expand
Harm
When: Unemployment is low
Influence: Rising prices or inflation
Result: Create more competition for scarce workers and resources and inflates wages
and prices
MONETARY POLICY
DEFINITION
Passage: a government policy which control a nationʼs money supply, is supervised by each
countryʼs central bank
GOALS
Exchange stability
Full employment and maximum output
Economic growth
Price stability
QUANTITATIVE TOOLS
Changing the reserve requirement
Definition: the percentage the Fed sets as the minimum amount of reserves as bank must
have
Fed increases the reserve requirements -> Banks have keep more reserves -> have less
money to lend out -> Descrease the money supply
Fed decreases the reserve requirements -> Banks keep less reserves -> have more money
to lend out -> Increase the money supply
Changing the Discount rate
Definition: the rate of interest the Fed changes for those loans
Fed increase the discount rate -> more expensive to borrow from the Fed -> have less
money to lend out -> Descrease the money supply
Fed decrease the discount rate -> less expensive to borrow from the Fed -> have more
money to lend out -> Increase the money supply
Open market operations
Definition: the Fedʼs buying and selling government securities
Fed sells Treasury bonds -> Collects some of IOUs -> Reduce banking system reserves->
Descrease the money supply
Fed buys Treasury bonds -> Increase banking system reserves-> Increase the money
supply
2 TYPES OF MONETARY POLICY
Expansionary monetary policy
Conditions for the occurrence
The economy is slowing down
Aim
To shi aggregate demand
Method: Increasing the money supply
Lowers reserve requirements, Drops the discount (bank) rate, Buy more bonds
Offering lower interest rate or easier approvals
Result
Increase bank lending capacity
Encourage people to borrow and spend more money -> A rightward shi of the
aggregate demand curve
Restrictive monetary policy
Conditions for the occurrence
The economy is overheating
Aim
To reduce aggregate demand -> to cool overheating economy
Method: Decreasing the money supply
Rasing reserve requirments
Incresing the discount rate
Selling bonds in the open market
Result
Reduce bank lending capacity
Curtail investment consumption, and even government expenditure
THE DIFFERENCES BETWEEN FISCAL AND MONETARY POLICY
WHO CONTROLS
FISCAL POLICY: The Ministry of Finance
MONETARY POLICY: Central Bank
TOOLS
FISCAL POLICY: Government spending and taxation
MONETARY POLICY: Changing the reserve requirement, Changing the Discount rate and Open
market operations
THE RELATIONSHIP
AIM: To maintain
Economic growth
High employment
Low inflation
