University of Education

Multan Campus

Submitted to Mam Shahida Parveen

Topic Fiscal And Monetary Policies
Submitted From Malik Fahad
Department Business Administration
Semester 3rd
Section A
 Fiscal and Monetary Policies | Macroeconomics

Fiscal Policy
Introduction

Fiscal policy is a crucial part of American economics. Both the executive and legislative
branches of the government determine fiscal policy and use it to influence the economy by
adjusting revenue and spending levels. It is used in conjunction with the monetary
policy implemented by central banks, and it influences the economy using the money
supply and rates. The objective of fiscal policy is to create healthy economic growth. Ideally, the
economy should grow between 2%–3% a year, unemployment will be at its natural rate of 4.7%–
5.8%, and inflation will be at its target rate of 2%. The business cycle will be in the expansion
phase.

History Commented [HF1]:

Fiscal policy is based on the theories of British economist John Maynard Keynes, which hold
that increasing or decreasing revenue (taxes) and expenditures (spending) levels
influence inflation, employment and the flow of money through the economic system. Fiscal
policy is often used in combination with monetary policy, which, in the United States, is set by
the Federal Reserve to influence the direction of the economy and meet economic goals.

Types of Fiscal Policy

There are two types of fiscal policy

1. Expansionary Fiscal Policy

2. Contractionary Fiscal Policy

Expansionary Fiscal Policy

The most widely-used is expansionary, which stimulates economic growth. Congress uses it to
end the contraction phase of the business cycle when voters are clamoring for relief from
a recession. The government either spends more, cuts taxes, or both. The idea is to put more

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money into consumers' hands, so they spend more. The increased demand forces businesses to
add jobs to increase supply.

Contractionary fiscal policy

The second type of fiscal policy is contractionary fiscal policy, which is rarely used. Its goal is to
slow economic growth and stamp out inflation. The long-term impact of inflation can damage
the standard of living as much as a recession. The tools of contractionary fiscal policy are used in
reverse. Taxes are increased, and spending is cut. You can imagine how wildly unpopular this is
among voters. Only lame duck politicians could afford to implement contractionary policy.

Tools

 Taxation

The first tool is taxation. That includes income, capital gains from investments, property, and
sales. Taxes provide the income that funds the government. The downside of taxes is that
whatever or whoever is taxed has less income to spend on themselves, which is why taxes are
unpopular.

 Government Spending

The second tool is government spending—which includes subsidies, welfare programs, public
works projects, and government salaries. Whoever receives the funds has more money to spend,
which increases demand and economic growth.

 Business tax policy

Taxes that businesses pay to the government affects profits and the amount of investment.
Lowering taxes increases aggregate demand and business investment spending.

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Monetary policy
Introduction

Monetary policy is a central bank's actions and communications that manage the money supply. That
includes credit, cash, checks, and money market mutual funds. The most important of these forms of
money is credit. It includes loans, bonds, and mortgages.

Monetary policy increases liquidity to create economic growth. It reduces liquidity to prevent
inflation. Central banks use interest rates, bank reserve requirements, and the amount of
government bonds that banks must hold. All these tools affect how much banks can lend. The
volume of loans affects the money supply.

Types of Monetary Policy

 Contractionary monetary policy

 Expansionary monetary policy

Contractionary monetary policy

Central banks use contractionary monetary policy to reduce inflation. They reduce the money
supply by restricting the amount of money banks can lend. The banks charge a higher interest
rate, making loans more expensive. Fewer businesses and individuals borrow, slowing growth.

Expansionary monetary policy

Central banks use expansionary monetary policy to lower unemployment and avoid recession.
They increase liquidity by giving banks more money to lend. Banks lower interest rates, making
loans cheaper. Businesses borrow more to buy equipment, hire employees, and expand their
operations. Individuals borrow more to buy more homes, cars, and appliances. That
increases demand and spurs economic growth

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Monetary Policy Tools

All central banks have three tools of monetary policy in common.

Open market operations

First, they all use open market operations. They buy and sell government bonds and
other securities from member banks. This changes the reserve amount the banks have on hand. A
higher reserve means banks can lend less. That's contractionary policy. In the United States, the
Fed sells Treasury’s to member banks.

Reserve requirement

The second tool is the reserve requirement. The central banks tell their members how much of
their money they must have on reserve each night. If it weren't for the reserve requirement, banks
would lend 100% of deposits. Not everyone needs all their money each day, so it is safe for the
banks to lend most of it out. That way, they have enough cash on hand to meet most demands for
redemption.

When a central bank wants to restrict liquidity, it raises the reserve requirement. That gives
banks less money to lend. When it wants to expand liquidity, it lowers the requirement. That
gives members banks more money to lend. Central banks rarely change the reserve requirement
because it requires a lot of paperwork for the members.

Discount rate

The third tool is the discount rate. That's how much a central bank charges members to borrow
funds from its discount window. It raises the discount rate to discourage banks from borrowing.
That reduces liquidity and slows the economy. It lowers the discount rate to encourage
borrowing. That increases liquidity and boosts growth.

In the United States, the Federal Open Market Committee sets the discount rate a half-point
higher than the fed funds rate. The Fed prefers banks to borrow from each other.

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 Fiscal and Monetary Policies | Macroeconomics