Any change in the government budget affects the overall economy of a country. A tight fiscal policy applies when revenue is at higher levels than spending, a budget surplus, and it is expansionary when revenue is at lower levels than spending, a budget deficit (Farrokh, 2002). In contrast, monetary policy describes the actions a country’s central bank takes to achieve stable inflation, price stability, high GDP, and increase in employment among other macroeconomic objectives. Automatic stabilizers characterize a passive type of fiscal policy, such that the system has already been set up, therefore, the congress has no need to take any further action. On the other hand, an active fiscal policy employs measures to either speed up or slow down the economy despite the fact that the system is already set up. An active monetary policy involves using of central banks in the management of interest rates and currency supply in the economy without considering the fiscal policies in place.
An active approach to fiscal and monetary policy strength lies in its ability to affect the total demand of a country such that a government can use it to restore output to normal level thus; help in responding to business cycle swings hence cushioning masses against unfavorable economic conditions, which economic stabilizers have failed to affect. According to Farrokh (2002), recessions bring forth hardships for many people thus a need for an active policy that can respond to such shocks and stabilize the economy. Moreover, the employment Act that was implemented in 1946 dictates that the government has a role to promote production and ensure full employment thus a need for an active policy. However, one of the weaknesses of an active fiscal policy is the issue of inside lag, and this is because of the fact that the president and congress usually take time to implement changes in the policy, thus the difference in time between when the need arises and when to use it becomes an issue. Moreover, the issue of outside lag affects the effectiveness of active policy because the time it takes after implementation and when the policy affects the economy is of concern. In any case, the economic conditions change before the policy impacts are felt, the policy may lead to economy destabilization.
Delegate your assignment to our experts and they will do the rest.
Automatic stabilizers such as income tax, welfare, and unemployment insurance slow down or stimulate the economy independent of policy change, and, as a result, reduce the lags that typify the stabilization policy. However, it is worth noting that the passive policy has enough resiliency to return to the required output within a reasonable period if it I caused by upsets of some shock (McEachern, 2013). Therefore, assuming the passive approach is reasonable because it steers of the variable and uncertain lags that an active policy might bring. Moreover, the effect any government policy may have on the economy is dependent on what people have come to expect. According to McEachern (2013), the theory of rational expectations posits that peoples’ expectations are governed by the available information, which can be from the past behavior of public officials. Therefore, established government policies are mostly anticipated as opposed to unexpected policies and thus have less effect than the unexpected policies. Secondly, policy conducted by rule ensures that policy makers announce the policy, and how it will respond to the situation in advance and commit to following through, thus taming the distrust that may arise among the policymakers and the political process, as well as the time inconsistencies. Finally, expansionary fiscal and monetary policies may be effective in the short run, but in the end, result in more inflation especially if the economy was already at or near its potential output, thus leading to federal deficits that can create uncertainty and instability.
References
Farrokh, K,L. (2002). Macroeconomic Policy: Demystifying Monetary and Fiscal Policy. Berlin, Springer Science & Business Media.
McEachern, W., A. (2013). Macroeconomics: A Contemporary Approach. Boston, Massachusetts, Cengage Learning.
