FISCAL AND MONETARY POLICY

BY: WINSTON A. GUILLEN

MACRO-ECONOMIC GOALS OF THE ECONOMY

• Full-employment• Full production• Price stability• Rapid growth

Growth/Output

TIME/PERIOD

BUSINESS CYCLE

1st Phase 2nd Phase 3rd Phase

1st Phase

• The first phase is expansion when the economy is growing along its long term trends in employment, output, and income

• At some point the economy will overheat, and suffer rising prices and interest rates

• until it reaches a turning point -- a peak -- and turn downward into a recession (the second phase)

2nd Phase

• Recessions are usually brief (six to nine months) and are marked by falling employment, output, income, prices, and interest rates.

• Most significantly, recessions are marked by rising unemployment.

• The economy will hit a bottom point -- a trough -- and rebound into a recovery (the third phase).

3rd Phase

• The recovery will enjoy rising employment, output, and income while unemployment will fall.

• The recovery will gradually slow down as the economy once again assumes its long term growth trends, and the recovery will transform into an expansion.

Approaches to Macro-economic Management

• Laissez faire. Before the Great Depression in the United States, the government's approach to the economy was laissez faire

• Keynesian Economics . But following the Second World War, it was determined that the government had to take a proactive role in the economy to regulate unemployment, business cycles, inflation and the cost of money. By using a mixture of both monetary and fiscal policies governments are able to control economic phenomena. British economist John Maynard Keynes’ theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when at a level between 2-3%), increases employment and maintains a healthy value of money.

HOUSEHOLD BUSINESS

Income payments

Factor services

Goods and services

Consumption expenditure

HOUSEHOLD BUSINESS

Income payments

Factor services

Goods and services

Consumption expenditure

CAPITAL MARKET

MONETARY POLICY

INTENDEDINVESTMENT

SAVING

HOUSEHOLD(deposable income )

BUSINESS(production)

Income payments

Factor services

Goods and services

Consumption expenditure

CAPITAL MARKET

MONETARY POLICY

INTENDEDINVESTMENT

SAVING

GOVERNMENT GOVERNMENTPURCHASES

TAXES

FISCALPOLICY

C, S, I, G

Y

Y = C + S

S

C

C, S, I, G

Y

Y = C + S

S

C

I

C + I

C, S, I, G

Y

Y

S

C

I

C + I

C + I + G

Full

Empl

oym

ent

gap

C, S, I, G

Y

Y

S

C

I

C + I

C + I + G

Full

Empl

oym

ent

gap

Basic Tools of Fiscal Policy

• Increase or Decrease of Government Spending• Increase or decrease of Taxation• Balanced-Budget Policy and the

“balance budget multiplier”• Pump Priming

Built-in Stabilizers:

• Progressive taxation• Social Insurance and Welfare

Services• Agricultural Support Policies• Leakages in the Private Sector

Tools of Monetary Policy

• Control of Money Supply through open market operations

• Changes in the required bank reserve requirement

• Changes in the Rediscount Rate• Moral Suasion

To Summarize:

• The government manages the overall pace of economic activity, seeking to maintain high levels of employment and stable prices & has two main tools for achieving these objectives: FISCAL POLICY, through which it determines the appropriate level of TAXES and SPENDING; and MONETARY POLICY, through which it manages the SUPPLY of money.

Fiscal Policy vs Monetary Policy

A Balancing Act

When the Economy has slowed down.(Unemployment levels are up,

consumer spending is down and businesses are not making any money)

• Appropriate Fiscal Policy?

• Appropriate Monetary policy?

When Inflation is too strong (very high prices real value of money and income id down)

• Appropriate Fiscal Policy?

• Appropriate Monetary policy?

Thank You