Introduction
The fiscal and monetary policy may be sharing some of the objectives of stabilizing the economy of a country like Mexico; however, each of the policy has specific objectives which are instrumental. Fiscal policy aims at promoting long-term growth of a country, redistributing the income and providing goods and services through the public expenditure. While monetary policy intends in controlling the level of prices, set money supply and the interest rate (Gillis 1992).
Fiscal and monetary policy can be applied in determining the aggregate price level and level of economic activities. These policies do affect the expectations of both households and firms ultimately affecting the decisions of the two will make. Fiscal policy will affect the aggregate demand by changing the government spending and taxation. The government spending and taxation will have an impact on the level of employment and household income, this will have a direct effect on how much can be left for investment and what the consumer can spend. Contrary to fiscal policy, monetary policy will have an impact on the money supply of the economy. This will have an influence on the interest and inflation rate. This policy also will affect the cost of debt, the rate of employment, and the relative cost of consumption saving (Aschauer 1985)
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To meet the four main economic objectives Fiscal policy is useful in promoting the macroeconomic stability through sustainment of the aggregate demand and the private sector can chip in a period of recession to moderate the economic activities. To achieve a low employment rate fiscal policy helps by increasing the aggregate demand and the rate of economic growth. The government will use the expansionary fiscal policy which involves a cut in taxes and increase in government spending. While monetary policy will involve a reduction in interest rates, low rates decrease the cost of loaning and motivate people to spend and invest. This will increase aggregate demand increasing GDP while reducing employment (Reifschneider 2000).
Side effects of Fiscal and monetary policy
Lags
The fiscal policy changes do engage a long implementation lag. Economists do believe that this long lag in fiscal policy leads to stabilization of the economy being ineffective. However, an economy with automatic stabilizers can avoid the long implementation lag by responding automatically to any changes in the economy (Burnside 2005)
Crowding out and in
It affects an expansionary fiscal policy by reducing its effectiveness. Either by increasing the government purchases or increasing transfers payments, reducing income taxes each of the policy will be increasing the deficit resulting to an increase of the government borrowing. This will lead to an increase in the supply of bonds, interest rates, and exchange rates while a fall in investments and exports. While crowding in will apply the contractionary fiscal policy leading to cut in the purchases of the government or reduce the transfer of payments. This policy will cause a deficit in the economy hence reduce government borrowing while interest rates will decline (Faal 2005).
Slows Production in a country
Contractionary monetary policy leads to low production in the economy leading to slow growth of the economy. In most cases, investment of capital and a low demand for goods and services are the culprits. Once production goes down it can take years before it can rise up again (Berg 2000).
The economic performance of the economy of Mexico over past 10 years
The chart below shows how the economy of Mexico has been performing since 2008. The section will cover the kind of policies that government of Mexico and the central bank used after the economic crisis the country had gone through.
The global financial crisis of 2008 had several negative effects in Mexico. There was an economic recession that led to the country's exports to decline in trading. There were possibilities of large increase in fiscal deficits and levels of public debt in the economy, an economy which was associated with adopting expansionary fiscal policies. There are concerns of an increase in the aging population and implementing financial programmes to support the economy.
Following the collapse of Lehman Brothers led to an immediate depreciation of the currency because of the volatility of the foreign exchange market. This came with several financial problems in various corporations incurring huge loses, this lead to a demand of the US dollar. Mexico's fiscal position became weak because the oil revenues had fallen, mostly due to a fall in international energy prices that brought due to the global recession also with the decrease of the production of domestic oil. Such conditions summing with rigidity in public expenditure raised ideas of bringing a sustainable fiscal policy.
Policies Mexican government used to control economic crisis of 2008
Mexico economy needed an adjustment to the new economy that was surrounded by lower foreign currency revenues and a limited access to external borrowing. The most suitable macroeconomic policies were a mix of policies both fiscal and monetary that could lead the country through the adjustments of lowest cost possible in terms of economic activities and inflation.
Fiscal policy during the economic crisis in Mexico
Fiscal policy of lowering the level of domestic absorption and demand for financing was necessary so that bring depreciation of the real exchange rate. However, this was a challenge in implementing an aggressive counter fiscal policy, which could have intended in making the real exchange rate adjustment in a different direction (Sidaoui 2010). Due to the effects of the crisis which started hitting the most vulnerable segments of Mexico, the government made the efforts of adopting measures to of trying to reduce the effects of the crisis on the economic activities mostly on low-income areas. Such measures were; increase in of public expenditure on infrastructure, a decrease in the electricity bills, ending household energy prices and implement of programmes that support jobs. However, in 2009 the economic recession became deeper, while the prices of oil lowered than it was anticipated for, this resulted to a decline in the public revenues. This situation made the fiscal position of the country to be weak.
The country had to adopt new control measure to end an increase of the fiscal accounts. The government employed non-recurrent revenue sources like savings that were initially used in oil revenue stabilization funds and exercise the oil price hedging option. The government was also on the need of implementing fiscal reform so that to make public finance strong. The fiscal strict measures were made the following year which included reducing the public expenditure, increase in taxes. Some of the other measures included increasing the VAT rate, both temporary and permanent rise in excise tax, increasing income tax temporarily. These fiscal efforts were able to amount to nearly 2% of GDP.
The Mexico government implemented the fiscal consolidated package under extreme conditions, which had a contraction of the economic activities. Nevertheless, this was able to improve its fiscal position. It can be incurred that the most recent concerns on sustainability of fiscal accounts in several euro economies deal with the risks of a weak fiscal position or the urge of implementing a corrective measure while in challenging circumstances. Lastly, fiscal consolidation was able to contribute in adjusting the real exchange rate of Mexico. Because government spending was mostly on non-tradable products, the actions were adopted to exert pressure on the pricing, hence this
Monetary policy during the economic crisis in Mexico
While the monetary policy was important since there was a rise in the price level which had been caused by the depreciation of the exchange rate in the economy of Mexico. This policy was important in preventing the inflation expectation from worsening, as this could have resulted in a further inflation outcome., hence there was a reduction in the scope of providing monetary stimulus. In the first 6 months of 2008, there was an increase in the international prices of products, this affected Mexico to have high inflationary pressure. As a result, the Central bank of Mexico made a decision to make some strict monetary policies. Such condition included an increase of interbank interest rate of 8.25% from 7.5%. Such measures were to prevent an increase in the inflation.
The following year, inflation had reached the peak and begun declining, while the prices of energy, food and output gap reduced inflationary pressure. The discouraging performance of the economy lead to the recession, as a result, the central bank started to lose the cycle in quickly it cut the policy rate from 8.25% to 4.5% (as shown on the representation below).
The effectiveness of the policies used in Mexico's economy
After Mexico changed its macroeconomic policy framework, the country was able to improve its fundamentals. A good example is the fiscal policy control which assisted in the elimination of the large and insistent budget deficit which previously the country had. This has contributed greatly to reducing the public debt the country had because a proactive policy of managing debt had been allowed to improve its structure (Villarreal 2010).
Final remarks
Mexico needs a mix of prudent fiscal and monetary policy so that the country can meet the fiscal targets in the face of low oil prices. It’s encouraging to see implementational structural reforms being undertaken as of today. Endless efforts by Mexican authorities are needed to ensure financial and macroeconomic stability.
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