Research Paper 2
Liberty University
PLCY-704
Chris Grady
04/05/2020
Monetary Policy vs. Fiscal Policy: An Overview
Monetary policy and fiscal policy refer to the two most widely recognized tools used to
influence a nation's economic activity. Monetary policy is primarily concerned with the
management of interest rates and the total supply of money in circulation and is generally carried
out by central banks, such as the U.S. Federal Reserve (Federal Reserve, 2019). Fiscal policy is a
collective term for the taxing and spending actions of governments. In the United States, the
national fiscal policy is determined by the executive and legislative branches of the government.
Monetary Policy
Central banks typically have used monetary policy to either stimulate an economy or to
check its growth. By incentivizing individuals and businesses to borrow and spend, the monetary
policy aims to spur economic activity. Conversely, by restricting spending and incentivizing
savings, monetary policy can act as a brake on inflation and other issues associated with an
overheated economy.
The Federal Reserve, also known as the "Fed," frequently has used three different policy
tools to influence the economy: open market operations, changing reserve requirements for
banks and setting the discount rate. Open market operations are carried out on a daily basis when
the Fed buys and sells U.S. government bonds to either inject money into the economy or pull
money out of circulation (2019). By setting the reserve ratio, or the percentage of deposits that
banks are required to keep in reserve, the Fed directly influences the amount of money created
when banks make loans. The Fed also can target changes in the discount rate (the interest rate it
charges on loans it makes to financial institutions), which is intended to impact short-term
interest rates across the entire economy.
Monetary policy is more of a blunt tool in terms of expanding and contracting the money
supply to influence inflation and growth and it has less impact on the real economy. For example,
the Fed was aggressive during the Great Depression. Its actions prevented deflation and
economic collapse but did not generate significant economic growth to reverse the lost output
and jobs. Expansionary monetary policy can have limited effects on growth by increasing asset
prices and lowering the costs of borrowing, making companies more profitable.
Fiscal Policy
Generally speaking, the aim of most government fiscal policies is to target the total level
of spending, the total composition of spending, or both in an economy (2019). The two most
widely used means of affecting fiscal policy are changes in government spending policies or in
government tax policies.
If a government believes there is not enough business activity in an economy, it can
increase the amount of money it spends, often referred to as stimulus spending. If there are not
enough tax receipts to pay for the spending increases, governments borrow money by issuing
debt securities such as government bonds and, in the process, accumulate debt. This is referred to
as deficit spending.
By increasing taxes, governments pull money out of the economy and slow business
activity. Typically, fiscal policy is used when the government seeks to stimulate the economy. It
might lower taxes or offer tax rebates in an effort to encourage economic growth. Influencing
economic outcomes via fiscal policy is one of the core tenets of Keynesian economics.
When a government spends money or changes tax policy, it must choose where to spend
or what to tax. In doing so, government fiscal policy can target specific communities, industries,
investments, or commodities to either favor or discourage production—sometimes, its actions are
based on considerations that are not entirely economic. For this reason, fiscal policy often is
hotly debated among economists and political observers.
Essentially, it is targeting aggregate demand. Companies also benefit as they see
increased revenues. However, if the economy is near full capacity, expansionary fiscal policy
risks sparking inflation. This inflation eats away at the margins of certain corporations in
competitive industries that may not be able to easily pass on costs to customers; it also eats away
at the funds of people on a fixed income.
While the full-employment budget provides a better measure of the thrust of fiscal policy
than the actual federal budget, impact measures provide additional insight into the direction,
magnitude, and composition of the changes in fiscal policy (Blinder et al, 1975, 78). These
measures are generated using a macroeconometric model to estimate the impact of changes in
fiscal policy in a given quarter on real GNP four quarters in the future (1976).
The aggregate fiscal policy impact measure is generated by comparing simulated real
GNP with the actual changes in fiscal policy that occurred in a particular quarter against
simulated real GNP without them. The influence of fiscal policy in time t on real GNP Y, in
period t + j is thus: Ten fiscal policy variables are held constant in the Y* simulation. They are
real federal government purchases of goods, personal income tax rate, profit tax rate, indirect
business tax rate, employee social security tax rate, employer social security tax rate, civilian
jobs, military jobs, transfer payments to households, and grants-in-aid to state and local
governments (Fair, 1984).
The results indicate that fiscal policy was highly contractionary in Eisenhower's first
term. Although fiscal policy in 1953 was expansionary, increasing estimated real GNP by $8.8
billion in 1954, this largely reflected the influence of the Truman administration (1984). The
aggregate impact measures for 1954 reveal that fiscal policy was exceedingly contractionary,
reducing estimated real GNP by $25.2 billion in 1955. This represents the largest yearly decline
of the Eisenhower tenure. Moreover, fiscal policy was contractionary in every quarter of 1954-
the only year in which this is true.
While contractionary policy in the early half of Eisenhower's first term is consistent with
the political business cycle hypothesis, the impact measures do not indicate that fiscal policy
became expansionary before the presidential election of 1956. While fiscal policy was more
expansionary in 1955 and 1956 than it was in 1954, it still reduced estimated real GNP by $5.1
billion in 1956 and $490 million in 1957.
The method used to estimate the impact measures is presented in Alan S. Blinder and
Stephen M. Goldfeld, "New Measures of Fiscal and Monetary Policy, 1958-1973," American
Economic Review, 66 (Dec. 1976, 78-96).
Economists have traditionally dismissed the policies preceding the 1960 presidential
election as evidence of Eisenhower's ongoing fiscal conservatism. While Eisenhower's
undeniable commitment to Republican principles and his relentless budget surplus rhetoric made
him appear to be "the rock of fiscal probity," the policies before the 1960 election cannot be
dismissed as evidence of his conservatism (Huges, 1987, 513).
Throughout his tenure the president presented an unusually consistent theme reaffirming
traditional Republican values and goals, chief among which was a belief in a minimal role for
government in the economic sphere. For Eisenhower, this minimal role was inspired by the belief
in the efficiency of the private sector in allocating resources and promoting economic growth
((The Economic Review, 1967, 72-79).
Minimal taxation was desirable so as not to stifle individual initiative or put undue
pressure on financial markets (Public paper of the President, 1960, 40). Moreover, the one goal
which resonates throughout Eisenhower's papers is that of achieving economic growth without
inflation. Maintaining a budget surplus was the primary mechanism through which low inflation
was to be achieved. Eisenhower's willingness to endure budget deficits became apparent during
the 1953-1954 recession and again during the 1957-1958 recession.
While it is no doubt true that a budget surplus had monumental significance to
Eisenhower, as Stein points out, "the desirability of balancing the budget was not given by some
eternal principle, but depended on economic conditions which would vary (Stein, 1969, 283).
In addition, the growing surpluses of the actual and full-employment budgets occurred in
years when inflation became more problematic. In 1955, 1956, and 1957 the rate of inflation was
above 3 percent, up from 1.6 percent in 1953 and 1954, and the full-employment budget surplus
increased from $3.9 billion in 1955 to $6.4 billion in 1958 (1988, 253). Thus, Eisenhower's
fiscal policy from 1953 through 1958 reflected consistent but flexible fiscal conservatism. The
size of the budget surplus increased Jonathan Hughes, American Economic Growth (Glenview,
1987, 513).
Competition and raising wages and prices were the main goals of New Deal industrial
and labor policies. There were two phases of policy during the 1930s. Both phases shared the
same objectives of raising wages and prices and used similar approaches to achieve these
objectives.
The Gold Standard
The gold standard was a standard regulating the quantity and growth of the country’s
monetary supply. Because new production of gold would add only a small fraction to the
accumulated stock, and because the authorities guaranteed free convertibility of gold into
nongold money, the gold standard ensured that the money supply, and hence the price level,
would not vary much. (Bordo, n.d.) Also, the standard was used to determine the value of a
country’s currency. So, those that participated in this standard maintained a fixed price for gold,
this price levels throughout the world moved together. The gold stand ensured long-term price
stability, however, because economies under the gold standard were so vulnerable to real and
monetary shocks, prices were highly unstable in the short run. (Bordo, n.d.)
The system is fine until there is a time of high demand, such as war. In World War 1,
countries involved needed an unlimited supply of ammunitions and war equipment in order to
win. A victory is unattainable if the gold needed to finance the seemingly limitless demand for
war equipment is in short supply. These times of high demand expose the limitations of the
standard in August 1971. Mr. Lawrence White’s arguments for the Gold Standard are very
compelling and the return to this system seems doable. However, this proposition is not made
without substantial opposition. “one influential line of argument holds that the Gold Standard
regime itself was responsible for the high degree of macroeconomic instability” (Fagan, Lothian,
& Mcnelis, 2013). White himself mentions the opposing views of the historian Barry
Eichengreen, a known critic of the gold standard. It is clear that for full conversion back to the
Gold Standard to actually happen in the United States, there would either have to be drastic
collapse of our current monetary system or someone like Senator Ron Paul would need to be
elected President.
The New Deal
During the 1930's, America witnessed a breakdown of the Democratic and free enterprise
system as the US fell into the worst depression in history. The economic depression that beset the
United States and other countries was unique in its severity and its consequences. At the depth of
the depression in 1933, one American worker in every four was out of a job. The great industrial
slump continued throughout the 1930's, shaking the foundations of Western capitalism. The New
Deal describes the program of US president Franklin D. Roosevelt from 1933 to 1939 of relief,
recovery, and reform. These new policies aimed to solve the economic problems created by the
depression of the 1930's.
When Roosevelt was nominated, he said, "I pledge you, I pledge myself, to a new deal
for the American people." The New Deal included federal action of unprecedented scope to
stimulate industrial recovery, assist victims of the Depression, guarantee minimum living
standards, and prevent future economic crises. Many economic, political, and social factors lead
up to the New Deal. Staggering statistics, like a 25% unemployment rate, and the fact that 20%
of NYC school children were under weight and malnourished, made it clear immediate action
was necessary (Kalleberg, 2017, 1-19).
In the first two years, the New Deal was concerned mainly with relief, setting up shelters
and soup kitchens to feed the millions of unemployed. However as time progressed, the focus
shifted towards recovery. In order to accomplish this monumental task, several agencies were
created. The National Recovery
Administration (NRA) was the keystone of the early new deal program launched by
Roosevelt. It was created in June 1933 under the terms of the National Industrial Recovery Act.
The NRA permitted businesses to draft "codes of fair competition," with presidential approval,
which regulated prices, wages, working conditions, and credit terms.
Businesses that complied with the codes were exempted from antitrust laws, and workers
were given the right to organize unions and bargain collectively. After that, the government set
up long-range goals, which included permanent recovery, and a reform of current abuses.
Particularly those that produced the boom-or-bust catastrophe. The NRA gave the President
power to regulate interstate commerce. This power was originally given to Congress. While the
NRA was effective, it was bringing America closer to socialism by giving the President
unconstitutional powers. In May 1935 the US Supreme Court, in Schechter Poultry Corporation
V. United States, unanimously declared the NRA unconstitutional on the grounds that the code-
drafting process was unconstitutional.
Another New Deal measure under Title II of the National Industrial Recovery Act of June
1933, the Public Works Administration (PWA), was designed to stimulate US industrial recovery
by pumping federal funds into large-scale construction projects. The head of the PWA exercised
extreme caution in allocating funds, and this did not stimulate the rapid revival of US industry
that New Dealers had hoped for. The PWA spent $6 billion enabling building contractors to
employ approximately 650,000 workers who might otherwise have been jobless (Prins et al,
2019, 131-144). The PWA built everything from schools and libraries to roads and highways.
The agency also financed the construction of cruisers, aircraft carriers, and destroyers for the
navy. In addition, the New Deal program founded the Works Projects Administration in 1939. It
was the most important New Deal work-relief agency. The WPA developed relief programs to
preserve people's skills and self-respect by providing useful work during a period of massive
unemployment. From 1935 to 1943 the WPA provided approximately 8 million jobs at a cost of
more than $11 billion. This funded the construction of thousands of public buildings and
facilities. In addition, the WPA sponsored the Federal Theater Project, Federal Art Project, and
Federal Writers' Project providing work for people in the arts.
In 1943, after the onset of wartime prosperity, Roosevelt terminated the WPA. One of the
most well known, The Social Security Act, created a system of old-age pensions and
unemployment insurance, which is still around today. Social security consists of public programs
to protect workers and their families from income losses associated with old age, illness,
unemployment, or death. The Fair Labor Standards Act (1938) established a federal Minimum
Wage and maximum-hours policy. The minimum wage, 25 cents per hour, applied to many
workers engaged in interstate commerce. The law was intended to prevent competitive wage
cutting by employers during the Depression. After the law was passed, wages began to rise as the
economy turned to war production. Wages and prices continued to rise, and the original
minimum wage ceased to be relevant. However, this new law still excluded millions of working
people, as did social security. However, a severe recession led many people to turn against New
Deal policies. In addition, World War II erupted in September 1939. Causing an enormous
growth in the economy as war goods were once again in great demand. No major New Deal
legislation was enacted after 1938 (Koltai et al, 2019). The Depression was a devastating event in
America, and by regulating banks and the stock market the New Deal eliminated the dubious
financial practices that had helped precipitate the Great Depression. However, Roosevelt's chief
fiscal tool, deficit spending, proved to be ineffective in averting downturns in the economy.
Reference,
1. Bordo, M. (n.d.). Gold Standard: The Concise Encyclopedia of Economics. Retrieved
from http://www.econlib.org/library/Enc/GoldStandard.html
2. Fagan, G., Lothian, J. R., & Mcnelis, P. D. (2013). WAS THE GOLD STANDARD
REALLY DESTABILIZING?. Journal Of Applied Econometrics, 28(2), 231-249.
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http://search.ebscohost.com.ezproxy.liberty.edu:2048/login.aspx?
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3. Jonathan Hughes, American Economic Growth (Glenview, 1987).
4. The method used to estimate the impact measures is presented in Alan S. Blinder and
Stephen M. Goldfeld, "New Measures of Fiscal and Monetary Policy, 1958-1973," American
Economic Review, 66 (Dec. 1976), pp. 78-96.
5. The four-quarter time horizon is used here because it represents a realistic impact lag and
because the dynamic properties of the macroeconometric model produce highly correlated two-
four-, and six-quarter impact measures.
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7. Economic Report of the President, 1956 (Washington, DC, 1956). pp. 72-79.
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