ECO/372Tj Weekj 5j Fiscalj andj Monetaryj Policyj Notes\
Fiscalj Policy
Thej USj Legislativej Branchj (Congressj andj Senate)j define,j implement,j andj governj USj fiscalj policyj whichj isj
thej nationalj expendituresj andj taxationj employedj toj stabilizej thej economyj
(https://www.britannica.com/topic/fiscal-policy)
Fiscalj Policyj Tools
Governmentj expendituresj (G)j whichj arej allj Federal,j State,j andj Localj governmentj purchasesj fromj paperj
clipsj toj aircraftj carriers.
Taxationj (T)j whichj isj impositionj ofj compulsoryj leviesj onj individualsj orj entitiesj byj governments.j Taxesj arej
leviedj inj almostj everyj countryj ofj thej world,j primarilyj toj raisej revenuej forj governmentj expenditures,j asj wellj
asj toj stabilizej anj economyj (https://www.britannica.com/topic/taxation)
Expansionaryj Fiscalj policyj isj implementedj duringj aj contractionj onj thej businessj cycle.
Expansionaryj Fiscalj policyj includesj increasingj Gj and/orj decreasingj T.
Thisj allowsj Aggregatej Demandj toj shiftj toj thej rightj andj movej anj economyj towardj growth.
Contractionaryj Fiscalj policyj isj implementedj duringj anj expansionj onj thej businessj cycle.
Contractionaryj Fiscalj policyj includesj decreasingj Gj and/orj increasingj T.
Thisj allowsj Aggregatej Demandj toj shiftj toj thej leftj andj minimizej thej economy’sj overheating.
Monetaryj Policy
Thej Federalj Reservej (thej Fed)j definesj monetaryj policyj asj itsj actionsj toj influencej thej availabilityj andj costj
ofj moneyj andj credit.j Becausej thej expectationsj ofj marketj participantsj playj anj importantj rolej inj determiningj
pricesj andj economicj growth,j monetaryj policyj canj alsoj bej definedj toj includej thej directives,j policies,j
statements,j andj actionsj ofj thej Fedj thatj influencej futurej perceptions.j However,j thej Fedsj cannotj controlj thej
inflationj directly;j instead,j indirectlyj byj affectingj thej moneyj supply,j itj isj theorizedj thatj monetaryj policyj canj
establishj rangesj forj inflation,j unemployment,j interestj rates,j andj economicj growth.j Thej Fed’sj primaryj
missionj isj toj ensurej thatj enoughj moneyj andj creditj arej availablej toj sustainj economicj growthj withoutj
inflation.j Ifj therej isj anj indicationj thatj inflationj isj threateningj ourj purchasingj power,j thej Fedj mayj needj toj
slowj thej growthj ofj thej moneyj supply.j Itj doesj thisj byj usingj threej tools—thej discountj rate,j reservej
requirementsj and,j mostj important,j openj marketj operations.
Monetaryj Policyj Tools
Openj marketj operation:j Thisj isj thej toolj thatj thej Federalj Reservej usesj thej mostj frequentlyj (onj aj dailyj
basis)j monetaryj policyj toolj toj involvesj thej buyingj andj sellingj ofj governmentj securitiesj inj orderj toj influencej
short-termj interestj ratesj andj thej growthj ofj thej moneyj andj creditj aggregates.j Wheneverj anj increasej inj thej
growthj ratej ofj thej moneyj supplyj andj creditj isj needed,j orj ifj downwardj pressurej onj short-termj interestj ratesj
isj desired,j thej Fedj sendsj securitiesj toj brokersj andj dealersj electronicallyj andj takesj paymentj byj debitingj
thej accountsj ofj banksj withj whichj thej brokersj andj dealersj doj business.j Thesej reservesj leavej thej bankingj
system,j therebyj reducingj thej moneyj supplyj andj curtailingj thej expansionj ofj credit.
Toj stimulatej thej economyj thatj isj experiencingj aj contraction,j thej Fedj willj increasej thej moneyj supplyj byj
buyingj securities.
Toj slowj downj anj overheatingj economyj thatj isj experiencingj anj inflationaryj expansion,j thej Fedj willj
decreasej thej moneyj supplyj byj sellingj securities.
Thisj isj donej onj aj dailyj basisj andj makesj incrementalj changesj toj thej moneyj supply.j j Inj aj sense,j openj
marketj operationsj tweakj thej moneyj supply.
Reservej Requirements:j Arej thej requirementsj regardingj thej amountj ofj fundsj thatj thej bankj mustj holdj inj
reservej againstj depositsj madej byj theirj customers.j Thisj moneyj mustj bej inj thej bank'sj vaultsj orj atj thej
closestj Federalj Reservej Bank.j Thisj toolj isj usedj toj maintainj thej minimumj amountj ofj physicalj fundsj inj theirj
reserve.
Reservej requirementj changesj arej notj madej veryj oftenj atj all.j j Theyj arej aj policyj usedj inj anj extremej
economicj situation.
Toj stimulatej thej economyj thatj isj experiencingj aj contraction,j thej Fedj willj increasej thej moneyj supplyj byj
decreasingj thej reservej requirementj allowingj banksj andj otherj financialj institutionsj toj loanj outj aj greaterj
fractionj ofj thej deposits.
Toj slowj downj anj overheatingj economyj thatj isj experiencingj anj inflationaryj expansion,j thej Fedj willj
decreasej thej moneyj supplyj byj increasingj thej reservej requirementj restrictingj evenj morej thej amountj ofj
moneyj banksj andj otherj financialj institutionsj arej allowedj toj loanj out.
Discountj Rate:j interestj ratej chargedj commercialj banksj andj otherj depositoryj institutionsj forj loansj thatj arej
receivedj byj thej Federalj Reservej Banks.j Thisj toolj isj importantj becausej itj isj aj visiblej announcementj ofj
changej inj thej Fed'sj monetaryj policyj andj itj willj givej insightj toj thej Fed'sj plans.
Likej thej reservej requirement,j thej discountj ratej changesj arej notj madej veryj oftenj atj all.j j Thisj policyj isj notj
usedj veryj often;j however,j thej Fedj isj increasingj thej discountj ratej today.
Toj stimulatej thej economyj thatj isj experiencingj aj contraction,j thej Fedj willj decreasej thej discountj ratej whichj
makesj borrowingj forj consumptionj andj investmentj friendlier.
Toj slowj downj anj overheatingj economyj thatj isj experiencingj anj inflationaryj expansion,j thej Fedj willj
increasej thej discountj ratej makingj savingsj morej attractivej thanj consumptionj andj investment.
Mostj importantj ofj thej Fed'sj responsibilitiesj isj monetaryj policy,j thej meansj byj whichj thej Fedj influencesj thej
growthj ofj moneyj andj creditj inj thej U.S.j economy.j j Whenj thej supplyj ofj moneyj growsj tooj rapidlyj inj relationj
toj thej economy'sj abilityj toj producej goodsj andj services,j inflationj mayj result.j Itj isj aj casej ofj tooj manyj dollarsj
inj thej handsj ofj buyersj chasingj thej samej amountj ofj goods.j j Onj thej otherj hand,j tooj littlej growthj inj thej
moneyj supplyj canj leadj toj suchj problemsj asj recessionj andj unemployment.j Asj thej moneyj flowj slowsj
down,j peoplej havej fewerj dollarsj toj spendj forj variousj goodsj andj services.j Businesses,j inj turn,j receivej
lessj moneyj forj thej goodsj andj servicesj theyj producej andj havej lessj toj spendj forj thej resourcesj theyj use.
Throughj monetaryj policy,j thej Fedj triesj toj avoidj eitherj ofj thesej extremes.j Toj doj so,j thej Fedj analyzesj thej
nationalj economyj andj seeksj toj influencej growthj inj moneyj andj creditj thatj willj contributej toj stablej prices,j
highj employment,j andj growthj inj thej economy.j j j Thej Fedj canj putj morej moneyj inj thej economyj -j actuallyj
createj moneyj -j byj buyingj U.S.j governmentj securitiesj onj thej openj market.j Thej Fedj paysj sellersj forj thej
securities.j They,j inj turn,j depositj thej moneyj inj variousj financialj institutions.j Whilej thesej institutionsj arej
requiredj byj lawj toj keepj aj certainj percentagej ofj thisj moneyj onj reserve,j theyj arej freej toj loanj outj thej
remainder.
Letj usj seej howj thisj works.j Supposej Janej Smithj isj holdingj aj U.S.j Treasuryj bond,j onej shej canj sellj atj anyj
time.j Throughj aj broker,j shej sellsj thisj bondj toj thej Fedj forj $1,000.j Atj thisj pointj thej Fed,j usingj powerj
grantedj toj itj byj thej U.S.j Congress,j paysj Ms.j Smithj byj creatingj $1,000j thatj didj notj existj before.j Ifj wej werej
toj writej aj checkj forj $1,000,j thatj moneyj wouldj comej outj ofj ourj bankj account.j Butj thej Fed'sj checkj createsj
newj moneyj byj addingj toj bankingj reserves.j Ms.j Smithj depositsj thej $1,000j inj Trustworthyj Bank.j
Trustworthyj mustj keepj aj certainj amountj onj reserve.j j We'llj supposej thej bank'sj reservej requirementj isj 10j
percent.j Ofj thej $1,000j deposit,j then,j Trustworthyj canj loanj outj $900,j knownj asj itsj excessj reserves.j Joej
Jones,j anj insurancej salesman,j needsj toj borrowj $900j forj newj computerj equipmentj forj hisj office.j
Trustworthyj Bankj creditsj Jones'j bankj accountj withj $900,j moneyj hej willj laterj repay.j Inj turn,j Jonesj writesj aj
checkj toj Computerwisej Co.j forj $900.j Thisj company,j inj turn,j depositsj thej checkj inj Reliablej Savingsj andj
Loan.j Reliablej mustj holdj backj 10j percentj onj reservej andj canj loanj outj $810.j Thisj processj goesj onj andj
on,j increasingj thej amountj ofj moneyj inj thej economy.j Whilej eachj financialj institutionj canj onlyj lendj anj
amountj equalj toj itsj excessj reserves,j thej financialj systemj asj aj wholej canj expandj thej amountj ofj moneyj inj
thej economy.
Asj youj canj see,j moneyj isj createdj inj ourj economyj inj twoj waysj thatj arej differentj butj related.j Thej Fedj
beginsj thej processj byj creatingj "rawj money"j whenj itj buysj aj Treasuryj securityj onj thej openj market.j Thej
bankingj systemj canj thenj expandj thisj amountj ofj moneyj byj lendingj it.j j Onj thej otherj hand,j ifj thej Fedj seesj
thej nationj isj threatenedj withj inflation,j itj mayj somej ofj thej securitiesj inj itsj portfolio.j Buyersj payj thej Fedj forj
thesej securitiesj outj ofj theirj bankj accounts.j Atj thisj point,j placesj likej Trustworthyj Bankj andj Reliablej
Savingsj andj Loanj havej lessj moneyj toj lend.j Inj thisj way,j thej Fedj removesj moneyj fromj thej economyj sincej
thej moneyj paidj toj thej Fedj doesj notj goj backj intoj anyj sortj ofj bankj account.
Aj secondj wayj inj whichj thej Fedj canj influencej thej economyj isj byj raisingj orj loweringj thej discountj rate,j thej
interestj ratej chargedj financialj institutionsj whenj theyj borrowj reservesj fromj thej Fed.j Althoughj seldomj
used,j discountj ratej changesj canj bej powerfulj signalsj ofj thej directionj ofj monetaryj policy.j
Thej Fedj canj alsoj havej aj powerfulj impactj onj thej flowj ofj moneyj andj creditj byj eitherj raisingj orj loweringj
reservej requirements,j thej percentagej ofj theirj depositsj thatj financialj institutionsj mustj keepj onj reserve.j Ifj
thej Fedj lowersj reservej requirements,j thisj canj leadj toj morej moneyj beingj injectedj intoj thej economyj sincej itj
freesj upj fundsj thatj werej previouslyj setj aside.j Onj thej otherj hand,j ifj thej Fedj raisesj reservej requirements,j itj
reducesj thej amountj ofj moneyj thatj institutionsj arej freej toj loanj outj orj invest.j However,j thej Fedj isj cautiousj
aboutj changingj reservej requirementsj andj hasj donej soj onlyj occasionallyj becausej ofj thej dramaticj impactj itj
canj havej onj bothj financialj institutionsj andj thej economy.
Lagj timesj forj Fiscalj Policyj andj Monetaryj Policy
Economistsj mustj considerj thej conceptj ofj lagj timesj withj respectj toj economicj behaviorj andj policyj
responsesj whenj developingj andj implementingj economicj policy.
Threej Lagj Timesj forj Fiscalj Policyj andj Monetaryj Policy
Recognitionj Lagj –j thej lagj timej betweenj aj changej onj thej businessj cyclej andj thej timej itj takesj forj analystsj
toj seej thej changej inj thej data.
Implementationj Lagj –j thej lagj timej betweenj seeingj aj changej onj thej businessj cyclej andj thej timej itj takesj
forj fiscalj policymakersj and/orj monetaryj policymakersj toj determinej aj resolutionj andj toj implementj thej
resolution.j Inj thej US,j fiscalj policyj hasj aj greaterj implementationj lagj timej thanj monetaryj policyj does.
Responsej Lagj –j thej lagj timej betweenj thej policyj implementationj andj thej responsej byj consumersj andj
firmsj toj changej behavior.
Asj aj result,j aj downturnj beginningj inj onej administrationj orj boardj ofj governors’j watchj mayj notj bej fullyj
realizedj orj resolvedj untilj thej newj policymakersj takej office.
Fiscalj v.j Monetaryj Policyj Lagj times
Fiscalj Policyj inj thej USj economyj involvesj thej gatheringj ofj data,j discussionj ofj bothj Houses,j deals,j andj
votej inj thej legislativej branchj whichj isj bothj thej Housej ofj Congressj andj thej Housej ofj Senate.
Monetaryj Policyj inj thej USj economyj involvesj thej gatheringj ofj data,j discussionj ofj thej Federalj Reservej
Boardj ofj Governors,j andj determinationj ofj thej policyj byj thej Chairj ofj thej Federalj Reserve.
Onj thej businessj cycle,j thej lagj timesj arej notj thej samej forj Fiscalj Policyj andj thej Monetaryj Policy.
Fiscalj policyj hasj muchj longerj recognitionj lagj timesj becausej thej legislativej branchj hasj manyj differentj
sourcesj gatheringj dataj onj quarterlyj andj annualj basis:j j Bureauj ofj Laborj Statisticsj (BLS),j Bureauj ofj
Economicj Researchj (BER),j Bureauj ofj Economicj Analysis,j Federalj Reserve,j diversej lobbyistsj sources,j
diversej privatej andj publicj institutionsj ofj higherj education,j andj internalj research.
Monetaryj policyj hasj muchj shorterj recognitionj lagj timesj becausej thej Federalj Reservej gathersj dataj dailyj
withj openj marketj operations,j asj wellj asj weekly,j monthly,j quarterly,j semi-annually,j andj annually.
Fiscalj policyj hasj aj veryj longj implementationj lagj timej becausej ofj thej processj involvingj bothj Housesj ofj thej
Legislativej Branch,j thej dealsj thatj takej place,j andj thej discussionj andj votej intricacies.
Monetaryj policyj hasj aj veryj shortj implementationj lagj timej becausej oncej thej Federalj Reservej Chairj hasj
determinedj thej necessaryj policyj (whetherj democraticallyj withj significantj inputj orj autocraticallyj withoutj anyj
input),j thej policyj canj bej implementedj immediately.
Fiscalj policyj hasj anj unpredictablej responsej lagj timej becausej householdsj andj firmsj needj toj knowj aboutj
thej policyj change,j thenj theyj mustj acceptj thatj thisj changej isj aj longj runj change,j notj aj shortj runj temporaryj
change,j andj thatj thej changej isj beneficialj forj themj personally.
Monetaryj policyj hasj aj relativelyj shortj responsej lagj timej becausej changesj inj interestj ratesj andj thej moneyj
supplyj canj bej observedj andj includedj inj decisionj makingj dailyj byj householdsj andj firms.
However,j bothj fiscalj policyj andj monetaryj policyj mustj bej implementedj andj respondedj toj onj thej rightj
phasej ofj thej businessj cyclej orj riskj exacerbatingj thej inflationj orj recession.j
