Ideally, the government would wish to manage aggregate demand so that it grows exactly in line with the underlying growth of potential , the dashed line in Fig. But when that fight threatened to increase unemployment, President after President reversed course, opting for stimulative policies to keep the economy growing and unemployment low. Monetary policy pertains to banking and credit, availability of loans to firms and households, interest rates, public debt and its management, and monetary management. Thus, they should be recognised as a very useful device of fiscal operations but not the only device. It soon became obvious that many Americans were being left behind.
That trust is tremendously important. Between January and August 2001, we had lowered our policy interest rate by 175 basis points. It is difficult to determine exactly what monetary policy to pursue because neither interest rates nor the money supply are perfect indicators of the restrictiveness of monetary policy. Expansions and contraction in money supply resulting from unregulated credit system is a major cause of instability in modern economies. Therefore, it is to the mutual benefit of both parties to co-operate in sharing information and analysis as they adjust their policy settings. Governments generally try to smooth out such fluctuations by stimulating aggregate demand when the economy is depressed and reducing aggregate demand when the economy is over-heating.
There is no guarantee that the first option would occur, though some monetarists believe the fixed-rate rule would ease unemployment problems. Taxation, on the other hand, operates to reduce the level of private spending on both consumption and investment by reducing the disposable income and the resulting savings in the community. Those neutralities are: the independence of consumption and current income given wealth ; the independence of investment and finance decisions the Modigliani-Miller theorem ; inflation stability only at the natural rate of unemployment; the ineffectiveness of macro stabilization policy with rational expectations; and Ricardian equivalence. If the Federal Reserve increases the money supply, it usually results in lower interest rates and an increase in aggregate demand for goods and services at a particular price level because money is cheaper to borrow. Though the quantity of money may be controlled by the banking system, the velocity of its circulation is not directly under the influence of banks. That is why reliance on built-in stabilisers, as far as possible, has been advocated.
As the author understands it, fiscal policy refer to those policies of the government that affect the tax rates, interest rates and expenditure, all used and controlled in an effort to control the economy. Thus, fiscal policy has quantitative as well as qualitative aspect changes in tax rates, the structure of taxation and its incidence influence the volume and direction or private spending in economy. During a depression, credit must be expanded and during an inflationary boom, its flow must be checked. Initially, the credibility of these policies was not high; so it was essential to demonstrate clearly our resolve to achieve greater fiscal prudence and lower inflation until credibility was gained. In general, the first method is probably superior to the second during a depression. Monetary policy, if used as a tool of economic stabilisation, in many ways, serves as a complement of fiscal policy.
However, the fundamental problem of monetary policy in relation to trade cycles is to control and regulate the volume of credit in such a way as to attain economic stability. Fiscal policy and automatic stabilization In Canada, the main automatic fiscal stabilizers are various types of tax revenues, as well as employment insurance payouts. The monetary and fiscal policy frameworks have created an environment where co-operation in the form of sharing information and analysis is most effective. The authorities could also exacerbate the fluctuation dotted line 1 if they get the magnitudes wrong by injecting too much purchasing power into the economy, creating conditions of excess demand. Classical4 Stabilization in South Africa5 Conclusion5 Reference list6 Introduction In an era where growth and stability in the economy are at the forefront of economic discussions, the economic policies and principles that are utilized in keeping with a stable economy must be taken very seriously. Journal of Money, Credit and Banking 1 3 : 507. Effectiveness of Monetary Control: Monetary policy is much more effective in curbing a boom than in helping to bring the economy out of a depressionary state.
Since the trend of inflation relative to the target is the best indicator of where demand is relative to potential output, this will be consistent with moving demand back into line with the new path of potential output over the medium term. But, as a practitioner, I can tell you that the great problem here is that temporary measures are both difficult to initiate quickly when the need arises and extraordinarily difficult to stop once the need is past. They can be introduced or changed quickly and easily: hence the effects of these can be rapid. Thus, changes in the reserve ratios can influence directly the cash volume and the lending capacity of the banks. Stability thereafter was a priority, not only in prices but in the economy as a whole.
Expansion and contraction of money as required, depending on the prevailing situation can be effected through a well-structured money and credit policy. In August, Fed Chairman Paul Volcker announced that the time had come to ease monetary policy. An upward shift in demand would, of course, generate symmetric responses. In the present world of globalization and growing international dependence, the possibility of instability getting transmitted, globally across the country, is higher. Monthly fine-tuning of monetary policy created havoc in the economy, When Paul Volcker initiated a new monetary policy designed to quell inflation once and for all, he made much of the fact that the new policy was on for the duration. Sometimes, direct government controls over prices and wages as a measure against inflation have been advocated and implemented.
But the bitter memories of the recession lingered on and faith in counter-cyclical policy was one of the casualties. Because of this, the profession moved on to growth theory and policy. In a peace-time economy, however, there are serious philosophical and political objections to direct economic controls as a stabilisation device Objections have been raised to such controls on the following counts: 1. Changing Taxes Increasing or lowering tax rates can also have an effect on aggregate demand. Of course, recent events show us in no uncertain terms that the stabilization problem has not been solved, and questions about how to stabilize the economy ought to be coming to the forefront again. But they offset only part of the change in output. Lesson Summary Market economies can create a vast amount of wealth, but they can also be messy, with erratic fluctuations in economic growth and decline.