Introduction
In the fiscal terms, a potential decline is considered as a slowdown in various economic activities. To move the country’s economy from recession, the federal government implements various expansionary economic policies. Expansionary policy can simply be considered as the macroeconomic policy aimed at expanding the money supply in the economy to stimulate economic growth or even to combat inflation (Dorman, 2014). One of the forms is the use of fiscal policy and it regards to tax cuts and increased government spending. Based on the recent economic crisis, studies have shown that critical examination of the Federal Reserve’s fiscal and monetary policy approach to the recession has developed into an area of key concern for many economists. Evidently, the classical as well as the Keynesian economic models conclude that government involvement has a great impact not only on consumption, but also on private investment and in the crowding-out effect (Chapter 7: Classical Macroeconomics and the Keynesian Challenge , 2016).
The Federal Reserve often implements expansionary policies to coincide with lowered standard funds, the discount rates or when purchasing the Treasury bonds in the open market, hence adding the significant amount of capital directly into the economy. Studies have pointed out that the Great Depression to a larger extends had challenged the classical model with a long depression and high rates of unemployment. According to Chapter 7: Classical Macroeconomics and the Keynesian Challenge ( 2016), Keynes attacked the classical model in two distinct ways. First, he acknowledged that there exist significant errors within the model and secondly, provided another model of macroeconomic section unlike the rest of the business cycle theorists. According to Keynes, a theory that only focuses on the long run is ineffective hence, he became increasingly preoccupied with the development of a theoretical model that will focus critically on short-run. The essay will thus focus on expansionary fiscal policy and expansionary monetary policy and how the federal government engages them to with the aim of moving the economy out of recession. The expansionary economic policy is adopted by the federal government to expand its money supply with an aim to boost the overall economic growth and inflation.
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Expansionary Fiscal Policy
Expansionary fiscal policy is specifically used by the federal government to address potential business-cycle inability which in most instances gives rise to various problems including unemployment creating a recessionary gap. According to Dorman (2014), this gap often arises when there is a business-cycle contraction leading to increased unemployment rates in the economy. The expansionary fiscal policy specifically energizes the economy during potential business phase recession. In the equation, the expansionary fiscal policy plays a critical role by narrowing or even closing down the recessionary gap specifically by energizing the economy through creating more jobs. The main goal of this policy is to close down the recessionary gap, to stimulate the economy and at the same time decrease the high rates of unemployment (Chapter 9: Taxes, Government Spending, and Fiscal Policy, 2016) .
The necessary change in taxes and government spending
The expansionary fiscal policy entails cutting the taxes and at the same time increasing the government spending. In line with this, lowering taxes will significantly increase the nonrefundable income which will further hint to higher levels of the user’s spending. The more the consumers spend then, the greater the chances for the country to achieve an increased economic growth. According to Chapter 9: Taxes, Government Spending, and Fiscal Policy (2016) , tax cut will increase the disposable income and such, will also increase the amount of money that’s available for depletion. An increase in depletion has also been established to increase the demand for both goods and services which further increases the gross domestic product which is the total output n economy produces in a given period.
The government levies taxes to receive revenue from its population. It is considered as the transfer of assets from the population to the federal government. In expansionary fiscal policy, the federal government uses fiscal policies to increase the amount of money in the economy. The government can decide to lower taxes and at the same time increase spending. When the government cut taxes then it will follow that the citizens will have more disposable income which is represented in the economic terms as Y = C(Y - T) + I + G + NX. In this equation, a decrease in T under a stable Y will result in an increase in the overall C and an increase in Y. Lowering taxes increase the disposable income of the consumers; this results in higher levels of consumer spending. This further will increase the overall aggregate demand leading to more economic growth.
Government spending is the second instrument and takes the form of social security, infrastructure, and wages to government employees. When the federal government spends; it significantly transfers assets to the public. Rising government spending will result in increased consumption. In a situation where the federal government increases its expenditure then the population providing such goods will receive more money. In economic terms, this can be represented as follows: Y = C(Y - T) + I + G + NX. A potential significant increase in G will then lead to a significant increase in Y. Therefore, in this case, an expansionary fiscal policy will make the make the population wealthier, and this will further increase output and national income (Cogan et al, 2010). The government will increase its spending in various areas such as infrastructure, education and even in unemployment benefits. Expansionary fiscal policy has however been argued to have the potential to lead to increased size of the government’s budget deficit (Chapter 9: Taxes, Government Spending, and Fiscal Policy, 2016) .
The effect on aggregate demand, GDP, and employment
Aggregate demand simply comprises of consumption as well as investment spending, government purchases of goods and services, in addition to net exports. Therefore, in situations where there is an increase in one of these components, then there will be a simulated output and employment. Aggregate demand, as it is a macroeconomic concept, is a summation of the demand for all goods and services within the economy. Focusing on expansionary fiscal policy, aggregate demand will measure the total demand for the economy's (GDP). In economic terms, aggregate demand is represented as AD = C + I + G + NX. The federal government will enact expansionary fiscal policy in response to potential recessions or employment shocks. According to Keynesian economics, expansionary fiscal policy will prevent a negative shift in the aggregate demand through stabilizing the rates of employment among the government employees. Extended unemployment benefits by the federal government will help to stabilize the population consumption and also the investment of individuals who were unemployed during the recession.
According to Keynesian model, an expansionary policy has the potential to increase the country’s GDP since it increases aggregate demand (Chapter 9: Taxes, Government Spending, and Fiscal Policy, 2016) . If the federal government cut tax then it will follow that both the population and businesses will utilize the tax saving to purchase more goods and services. An increase in purchases will stimulate the economy to produce more goods and services demanded which further increases output and productivity (Cogan et al, 2010). When the federal government increases its spending, then it will follow that the increasing demand from the government will prompt all producers to increase production to meet this demand (Chapter 9: Taxes, Government Spending, and Fiscal Policy, 2016) . It has been established that an increase in the aggregate demand will drive production which will further benefit the labor market. When producers increased their productivity to meet the current demand, it will follow that they will hire more workers to support this growth hence addressing issues related to unemployment.
Expansionary Monetary Policy
Expansionary monetary policies are vital in boosting the total amount of money that flows throughout the country’s economy. In this policy, an appropriate amount of interest is often decreased to specifically boost the economy and manage both the business-cycle contraction unemployment issues (Chapter 14: Monetary Policy in Theory and Practice, 2016). In general, expansionary monetary policy can simply be considered as an increase in the total quantity of money in circulation which at the same time, tends to significantly correspond to reduced interest rates. Usually, this is meant to attain economic stimulation, in turn, preventing potential business cycle contraction and further, addressing unemployment issues. In the expansionary monetary policy, the federal government uses three distinct tools to influence the economy including: open market operations, reserve requirements, and the discount rate. Open market operations entail purchasing selling the government securities. According to Geraats (2006), the federal government does not make a decision on its own on the type of security dealers to do business with, but the choice will emerge from the open market where security dealers will compete based on price. On the hand, the discount rate is simply the interest rate that is often charged by the Federal Reserve Banks to the depository institutions on the short-term loans. Reserve requirements are simply deposited portions that have to be maintained by the banks in their deposits at the Federal Reserve Bank.
Open market operations
The federal government, primarily, applies the open market towards significantly influencing the overall supply of the bank reserve. Expansionary Monetary Policy, in this case, will entail buying Treasury securities within the open market. This significantly keeps the interest rates low by expanding the overall money supply through the open market operations. The instrument entails Federal Reserve purchases and sales of the financial instruments especially securities that are issued by the U.S. Treasury, the Federal agencies and even the government-sponsored enterprises. To increase reserves, the Fed will buy securities and then pay them through making deposits to the account that are maintained at the Fed specifically by the primary dealer’s bank. The open market operation is the most commonly used instrument by the Fed to affect its expansionary monetary policy. The Fed purchases Treasury notes from the member banks (Chapter 14: Monetary Policy in Theory and Practice, 2016). Through the process of replacing Treasury notes with the credit in the bank coffers, the Fed provides more money to them for lending. This makes the banks to lower their lending rates hence making loans less expensive. The cheaper credit card interest rates further boost the consumer spending in the economy. Further, in a situation where business loans become affordable, various companies expand their operation productivity to meet the current market demand. According to Geraats (2006), to achieve this, the companies employ more workers raising their income significantly which increases their purchasing and consumption. This significantly stimulates the economy’s demand hence driving the economic growth to approximately 2-3 percent rate.
Discount rates
The Fed charges those banks that borrow from its discount window. The Fed can also reduce the rates that are charged to banks wishing to borrow directly from the central bank and it is referred to as discount rate. In most instances, banks do not use the discount window provided since they believe that there is a form of the stigma attached to it. Fed has always been considered as the lender of last resort. Most banks tend to make use of the discount window in a situation where they could not access any loan from other banks. There are instances when Fed lowers the discount rate especially when they lower the target for the Fed funds rate (Chapter 14: Monetary Policy In Theory And Practice, 2016).
Reserve Requirements
This is simply the proportion of the client’s deposit that the bank is required by the Federal Reserve to hold in reserve. This reserve will enable banks to have sufficient cash on hand that will cover money withdrawals that might be needed by consumers on a regular basis. According to Geraats (2006), the Federal Reserve demand that commercial banks maintain reserves to give them more control over the money supply. In effecting its expansionary monetary policies, the Fed lowers the amount of reserves required for all the commercial banks to hold, referred to as reducing the reserve requirement. This significantly increases the number of loans issues to the public and business. This will further imply lower interest rates and greater economic output (Chapter 12: Banking and The Federal Reserve System, 2016).
Effect of these actions on the money supply, interest rates, spending, aggregate demand, GDP, and employment
These instruments have been established to be effective to increase the amount of money that will be in circulation, reducing the interest rates and further stimulating the overall economic growth. According to Geraats (2006), during the recession, the Federal government cut the interest rates with an aim to boost economic growth. An increase in money supply will increase capital availability which will, in turn, impact aggregate spending or investment. An increase in the quantity of money in the economy will be mirrored by an equal increase in the overall Gross Domestic Product. Evidently, the increased money supply will further result in increased consumer spending shifting the aggregate demand curve to the right. According to Chapter 12: Banking and The Federal Reserve System ( 2016), The interest rates will be very low in the economy enabling the citizens and companies to access loans much easily. This will result in increased disposable income where the population will be able to increase their consumption which further translates into increased aggregate demand. In addition to this, companies will have more capital available hence will increase their productivity to meet the high demand in the market. Further, the companies will be forced to employ more workers to help in the production of more commodities to meet the demand solving the issue of unemployment.
Conclusion
In order to move the economy out of a recession, the federal government, usually would engage in expansionary economic policies. Both expansionary fiscal and monetary policies back each other to end the recession. The expansionary fiscal policy, on the one hand, improves the economy through expanding the overall aggregate demand and expenditure through lowering and increasing taxes. However, it has been established that the expansionary fiscal policy can lead to a huge financial shortage or even small financial plan with an excess. Clearly, spending and taxes are considered two major sides of the federal government fiscal policy and thus the expansionary fiscal policy employee both. Expansionary fiscal policy will thus lead into leads into a huge government budget deficit or even a smaller budget surplus. In long-term, it has been established that expansionary fiscal policy will have a negative effect on the country’s real GDP since the long-range aggregate supply curve does not change. In the long run, expansionary fiscal policy will increase the price level causing the short-term aggregate supply curve to shift to the left. The AD curve will intersect the long-range aggregate supply curve at a point hence reflecting higher price level and lower real GDP.
Focusing on Keynesian economists, it has been established that the economy is intrinsically unstable and further, that the fiscal policy is more effective compared to monetary policy. This is the case because an expansionary fiscal policy has the potential to be structured to reduce potential crowding-out of investment expenditures. On the other hand Monetarist, economists have come out clearly rejecting the Keynesian argument arguing that the economy is intrinsically stable therefore monetary policy is more stable since fiscal policy will result into increasing crowding-out of investment.
References
Chapter 7: Classical Macroeconomics and the Keynesian Challenge . (2016). Class.
Chapter 9: Taxes, Government Spending, and Fiscal Policy. (2016). Class.
Chapter 12: Banking and The Federal Reserve System. (2016). Class.
Chapter 14: Monetary Policy In Theory And Practice. (2016). Class.
Cogan, J. F., Cwik, T., Taylor, J. B., & Wieland, V. (2010). New Keynesian versus old Keynesian government spending multipliers. Journal of Economic dynamics and control , 34 (3), 281-295.
Dorman, P. (2014). Classical Economics and the Keynesian Challenge. In Macroeconomics (pp. 225-239). Springer Berlin Heidelberg.
Geraats, P. M. (2006). Transparency of monetary policy: Theory and practice. CESifo economic studies , 52 (1), 111-152.
