Introduction
Nations all over the world are continuously involved in trade activities. Trading involves the exchange of material goods or services at a price. Trading practices have been enhanced through the continued use of technology. Trading institutions and governments are able to monitor events and trade opportunities happening within the global economy. Many industries have become effective with the continued adoption of technology in their operations. Governments, with the assistance of technology, have had to develop and control trading activities within their nations . Where these activities are left unattended, there is a risk to the economic development. Continued management of trading activities within the country allows a government to analyze the position of the economy and its position within the global economy (Madura, 2014). Management of businesses and trading activities within the nation is a crucial factor in the development of the nation ’ s economy. The government needs to ensure there is a growth in the number of businesses and consumers who are trading with the country. This prevents the risk of reduction of demand due to loss of consumer confidence or business growth. Where consumers stop trading with a particular market, businesses are unable to run advertisements within that market due to reduced revenue incomes. Manufacturers reduce the number of goods they produce as they receive less orders, as there are no sales within the market and consequently unemployment rates begin to rise. There is a continued decrease in the gross domestic growth rate, a sign which indicates that a recession may be underway. Continued fall in these rates ultimately leads to a recession occurring within that economy.
During a recession, there are certain actions the government is expected to do in order to tackle the falling rates of GDP and money supply within the economy (Mankiw, 2011). These actions include the development of expansionary economic policies that are utilized to provide other avenues for money supply to the economy. They are also used to combat rises in inflationary prices within the industry, hence ensuring that the economy is restored to its proper functionality. Determining the effect of these policies on an economy currently facing an economic recession is important (Mankiw, 2011). A critical analysis on the actions expected of the government when implementing these policies is conducted in this study, with the key focus being on the actions taken when implementing expansionary fiscal policies and expansionary monetary policies which are the two major actions under the expansionary economic policies.
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Expansionary Policies
The expansionary policies are defined as macroeconomic policies which are enacted in order to expand the money supply within a given economy, and also encourage the growth of the economy from the current level. These expansionary Policies are utilized in order to inject a direct growth in the demand of products within the economy, by engineering situations which foster such growth. The policies are divided into Expansionary Monetary Policies and Expansionary Fiscal Policies.
Expansionary Fiscal Policy
The Expansionary Fiscal Policy is one of the forms of expansionary economic policies which are enacted by the government in the event of a recession. According to Ahtiala & Kanto (2002), fiscal policies are budgetary tools that are utilized by the government in order to expand the money supply within the economy. They use these tools in order to increase spending within the economy and allow for a rise in the rate of consumption and aggregate demand within the economy. Consequently, with the continued rise in the rate of consumption and aggregate demand, there is a growth in the economy. Essentially, expansionary fiscal policies are defined as the use of government expenditures and taxes in order to influence the economic activities. The fiscal policies implemented can include cutting of tax on incomes or increased investments in public work schemes.
Cutting Tax Incomes
Income taxes have a large effect on the consumption component of aggregate demand. Aggregate demand is defined as the total demand that is within a given market for products and services produced in the market. It is comprised of the consumption rate, plus the various investments being made within the economy, the governments ’ expenditure and the net exports within that particular economy. Government taxation policies are a major contributor to the rate of aggregate demand within a given market. When the tax rates are high, then the product prices and services will also be high, where they are minimal, product prices and rates also decrease (Mankiw, 2011). During high peaking economic seasons, the aggregate demand may exponentially increase as consumers within that economy have enough disposable income to purchase a variety of items. Businesses are constantly running as there is a constant rate of demand and supply within the market. Orders received from businesses are consequently forwarded to manufacturers who continue producing products to satisfy the need within the market. However, during a recession, the aggregate demand rate drastically reduces and businesses incur losses due to the lack of demand (Ahtiala & Kanto, 2002). There is little supply of products within the industry, and consequently, any manufacturers are unable to continue producing products, which consequently affects the Gross Domestic Product (GDP). GDP is defined as the total value of goods and services which are produced and provided by a country within a year. Employment rates also decrease as many firms are unable to sustain employees ’ wages and salaries while covering the operating expense. When this occurs, the economy is said to be experiencing a recession (Bertella et al., 2015).
During a recession, consumers are disadvantaged and mostly utilize their incomes for the provision of basic needs to their families. In most cases, product prices and other services may be foregone entirely as the consumers are unable to afford them. The weight of income taxes may also be an additional challenge to consumers. Imposing income tax reduces the capability of consumer purchase as it poses lower incomes due to the tax deductions. As a result, the government may change the fiscal policies to allow for expansion of money supply within the economy (Mankiw, 2011). To achieve this, the government may choose to cut taxes imposed on incomes. Cutting taxes imposed on the incomes of the people will allow citizens to have the same amount of disposable income. The people will be able to afford more products within the market, businesses will begin receiving a demand for their products and consequently increase the aggregate demand for products within the market. Manufacturers will start receiving supply demands for products, as a result, increasing the GDP of the economy (Tabak, Moreira, Fazio, Cavalcanti, & de Moura Cunha, 2016). As aggregate demand for products continues to increase, there will be a requirement for more employees in order to handle all the demand requests. As a result, the rate of employment will increase and pull the economy out of the recession.
Government Spending
Another method which the government can employ in order to increase economic activity is increasing its spending. The GDP during a recession is normally lower and hence, the government seeks to tip the scales and increase the GDP of the economy. During the recession, the lack of business creates low demand, what the government fosters by increased spending is the increase in demand for products and services. Consequently, the economy is able to function as there is a continuous flow of money supply within the market. A government is able to run a surplus by utilizing more money than it is taxing. Hence, when increasing its expenditure, the government has to ensure it has reduced the rate of taxation on income (Mankiw, 2011). The more the government is spending, the higher the chances that someone else is receiving the money they are spending. Hence, they increase the capacity of individual spending within the economy.
A government is able to increase its spending through public sector investments and projects. During a recession, private businesses slowly recede from conducting any major investments due to the cash-constraints. The firms begin downsizing as they are unable to meet their monthly incomes. The government responds to this by investing in projects. For instance, by funding a project for the construction of a building or a major highway, the constructor requires there to be employees who would be available to assist in the construction work. This translates to development of employment opportunities and slowly, those employees losing opportunities in the private sector are able to find employment opportunities in government-sponsored works (Madura, 2014). The private sector gradually improves as government purchases continue to increase the demand for both labour and raw materials in the economy. Consequently, the investment in these works leads to continued increases in employment opportunities. As the government continues to purchase required raw materials to produce the finished goods, they continue to work with suppliers in the private sector. With continued demand, these suppliers require more employees to work additional shifts in order to meet the demand (Bertella et al., 2015). As a result, they continually require additional employees to satisfy this demand. More people being employed lead to an increase in the disposable income that is present within the economy. Consequently, the GDP rate increases as aggregate demand continues to increase.
In many cases, for a faster outcome, both reductions in taxes and government spending are used simultaneously in order to yield faster results within the economy (Madura, 2014). As the government continues to spend, income taxes are cut to ensure there is more disposable income. Lower income taxes increase the demand for products. Increase in demand affects supply of products. Ultimately, the expansionary fiscal policies lead to an increase in the aggregate demand of products and services within that particular economy and consequently improve the GDP of the nation pulling the country from the recession.
Expansionary Monetary Policy
According to Mankiw (2011), monetary policies are defined as tools which the central bank of any country utilizes in order to manage the liquidity of the nation and create economic growth. Liquidity in this sense refers to the money that is available for investment and spending within the nation. These funds include credit, cash, checks and a collection of stocks, bonds and other securities within the market referred to as money market mutual funds. The main aim of monetary policies is to manage the rate of inflation and ensure the unemployment rates are reduced and economic growth is constant. The United States Federal Reserve (The Fed) is responsible for ensuring that these objectives are meant (Tabak et al., 2016). During a recession, in addition to having expansionary fiscal policies implemented, The Fed may also choose to implement Expansionary Monetary Policies.
Expansionary Monetary Policies are tools which are used by the central bank of a country in order to stimulate the economy and increase the money supply. The policies seek to reduce the interest rates within that particular economy and foster a situation where the aggregate demand for products and services is increased. The policies when put in place are able to boost the economies demand for the product and increase their growth as measured by the GDP (Tabak et al., 2016). The Expansionary Monetary policies work by reducing the value of the currency in order to decrease the exchange rate. The Fed may implement these policies through the required reserve ratio, the discount rate, and open market operations.
The reserve ratio is the least used tool by the Fed during a recession. It is the amount of money which member banks of the Central bank are to have at the end of each night. The Fed sets the percentage rate of this amount. It is through these amounts that the percentage of bank ’ s deposits are measured. These reserves are applicable to all savings, commercial, credit unions and loan associations (Mankiw, 2011). Where a bank is unable to reach the reserve ratio set by the Fed, it borrows from other banks. Where other banks are also not able to assist, the bank borrows from the Fed in order to offset the reserve rate. The loan borrowed is at a certain rate known as the fed funds rate which bases all other interest rates. Where the Fed reduces this rate, it creates a situation where there is more money within the banking system allowing more banks to lend and increasing liquidity in the economy (Bertella et al., 2015).
The most used tool in Expansionary Monetary Policies is the use of open market operations. In these operations, the Fed purchases treasury notes from the member banks. The funds that are utilized for these transactions are referred to as printed money, as the Fed generally creates the credit that is used to purchase the notes out of thin air. The move is meant to convert the treasury notes into credit so that there can be more money which the member banks are able to lend (Bertella et al., 2015). These banks reduce their lending rates and reduce the interest rates on loans for auto, school, homes and credit cards. This extra credit continues to boost consumer spending within the economy and thus leads to an economic growth. Similarly, the affordability of these business loans allows the organizations to handle the rates of consumer demand, they create more employment opportunities with an aim of meeting and satisfying consumer demand (Bertella et al., 2015).
The Fed may spur the economic growth through the use of the discount rate. The discount rate is the amount of money, (i.e. interest rate), the U.S. central bank is charging its member banks in order to borrow from its discount window and maintain the reserve ration which is required of the member bank (Madura, 2014). A discount window is the defined as the money which is loaned to a member bank in order to ensure that it is able to meet the reserve requirement. These loans are conducted as banks close each night. The member banks post collateral to the Central bank in order to ensure they are able to repay these loans. The collateral involved in these payments may be treasury bills, bonds, notes, state securities, consumer bonds, and commercial loans (Madura, 2014). Hence, during a recession, the Fed reduces the discount rate to allow more banks to be able to borrow loans from the Fed through the discount window and also decreases the Fed funds rate.
However, in enacting the Expansionary Monetary Policies, it is important to ensure the inflation rate does not increase due to the measures enacted. Inflation is the rate at which products and service prices within a given economy rise and fall. The Fed is responsible for ensuring that the inflation rate is not too high limiting the purchasing power of consumers within the market (Madura, 2014). The monetary policies enacted provide the consumers and businesses with opportunities to acquire loans from banks. If the buyers set the prices of products and services too high, then the implicit value of that currency falls as many people are unable to purchase products. The Fed has to balance the inflation rate and ensure the currency remains relevant and in demand within the market.
Conclusion
From the study, it is evident that expansionary Policies are enacted where the Fed observes that the country may be going into a recession, or when there may be a sudden drop in the aggregate demand and GDP rates within the nation. The expansionary monetary and expansionary fiscal policies are implemented to ensure that both buyer and supplier are able to keep the money supply moving within the economy. The Expansionary Fiscal Policies place importance on the buyer or consumer of the products and provides a suitable setting for the consumer to continue demanding for products within the market. The Expansionary Monetary Policies place concentration on the suppliers of products within the economy. Where the client demand for products reduces, the Fed provides new environments where demand can be increased and hence keep the businesses in play. Consequently, all these actions lead back to the manufacturers who are able to keep producing products and hence maintain the country ’ s GDP. Consequently, these tools ultimately lead to a growth in the economy. During a recession, the implementation of both expansionary monetary policies and expansionary fiscal policies assist the government to better increase the money supply within the economy and thus foster continued money supply. As a result, the policies are able to affect the aggregate demand for products and services and give a rise to the gross domestic product of the country.
References
Ahtiala, P., & Kanto, A. (2002). Contractionary effects of expansionary fiscal policy: theory and tests. Economic Modelling , 19 (1), 137–152.
Bertella, M. A., Rego, H. A., Neris Jr, C., Silva, J. N., Podobnik, B., & Stanley, H. E. (2015). Interaction between fiscal and monetary policy in a dynamic nonlinear model. PloS One , 10 (3), e0118917.
Madura, J. (2014). Financial Markets and Institutions . Cengage Learning. Retrieved from https://books.google.co.ke/books?id=rcUTCgAAQBAJ
Mankiw, N. G. (2011). Principles of Economics . United States of America: Cengage Learning. Retrieved from https://books.google.co.ke/books?id=nZE_wPg4Wi0C
Tabak, B. M., Moreira, T. B. S., Fazio, D. M., Cavalcanti, A. L. C., & de Moura Cunha, G. H. (2016). Monetary Expansion and the Banking Lending Channel. PloS One , 11 (10), e0164338.
