Question

Answer the following questions:

A- What is discretionary and non-discretionary fiscal policy?

B- What are the available tools of fiscal policy?

C- What is monetary policy and who conducts it?

D- What are the available tools of monetary policy?

Using these introductory questions, present a detailed essay-type analysis, with all the information from a reliable source, of what consists of at least three fiscal policy incentives and one monetary policy incentive as a consequence of the COVID-19. In total, at least four economic incentives that apply in Puerto Rico and/or the United States must be presented. In its analysis it must present a sequence of expected impact on the aggregate demand and aggregate supply curves and what the main incentive objective should be on the country's economic growth. It must present its arguments with all the analysis discussed in the course of the expected sequence of positive and negative reactions on the macroeconomic balance, identifying what type of fiscal and monetary policy is being activated and which macroeconomic variables (consumption, investment, government expenditure, exports and imports) are expected to be impacted.

Answer 1

Answer to Part A & B)

A fiscal policy is one which is conducted by the government and is widely used as a measure to correct the economy during times of crisis such as Inflation or recession.

The tools of managing fiscal policy include the following: -

1) Taxes: -

Direct and Indirect taxes are a way in which fiscal policies are best managed. Direct Taxes are collected directly from the person who lives in the country for example corporate tax or income tax are all forms of direct taxation. On the other hand, indirect taxes include those which are collected over sales of goods and services or manufacturing for example Goods and Services Tax and Value added tax are examples of Indirect taxes.

Now, coming to how the government uses this, consider that the economy is going through a recession cycle. During this time, the government reduces the tax rates and this provides the much-needed support to the economy which can then recover from the cycle.

2) Government Spending: -

The second alternative which the government has is government spending. This is largely seen as a move that helps the economy in remaining stable. During the Covid crisis for an example, most governments increased their spending towards the health care sector which has provided the much-needed relief during this time period.

Now, coming to discretionary and non-discretionary policies, discretionary are the one that are implemented for the first time on case basis. For example, the government of Untied States passed the "Corona Virus Preparedness and Response Supplemental Appropriations Act" as a discretionary policy aimed to correct the ill effects of the disease on the economy.

On the contrary non-discretionary ones are permanent and are not changed much over time example social security which goes on for a long period of time.

Part D & E)

The Monetary Policy is primarily conducted by the Central Bank of a country which is a tool to control the flow of money in any economy. The Central Bank reviews the status of inflation and growth in any economy from time to time, and if required uses the following policy tools to correct the economy.

1) Interest Rates: -

The Central Bank charges interest rates from commercial ones to grant as loans. As these are modified, the nature of the economy also experiences a drastic change. For example, during a recession, the currency in circulation is low. To correct this the Central Bank reduces the Interest Rates and this allows higher stability in the economy. It can also increase the same during an inflation. Due to reduced interest rates, more people come forward to consume more and the nature of the economy largely changes.

2) Reserve Ratio: -

The Reserve Ratio is another method in which the Monetary policy is conducted. This is the minimum amount of money which the Commercial Banks are required to hold at any given point of time in the economy. For example, during a recession, the flow of money in a country is extremely low. Therefore, reducing the minimum required funds which commercial banks must holds results in addition of working capital for banks and this allows them to function in a better manner.

3) Open Market Operations: -

Another technique used by the Central Bank is to purchase or to sell bonds in the open markets. For example, consider a situation of recession and the Central Bank chooses to purchase securities that banks or other people hold. The reserve then directly supplies additional currency and the economy can remain stable. The opposite can be done during an inflation cycle and the Central Bank can sell bonds and remove currency from circulation.

Steps Taken to Counter the Corona Virus Crisis: -

The following are the steps which have been taken up by the government and the Federal Reserve of the United States to correct the effects of the Corona Virus Pandemic which has resulted in wide spread recession in the country.

Fiscal Measures: -

1) Direct Cash Transfer: -

The government of United States has provided a direct aid of 1200 US dollars to anyone who earns bellow 75000 US Dollars in a year. The aim of this is to maintain a healthy economy and to ensure that the aggregate demand for goods and services remains stable over a period of time.

Consider the package as a demand stimulus which is aimed at ensuring that the people can continue to consume in the same quantity that they used to earlier. This helps in increasing the incentive for producers to produce the same quantity of goods and services and keeps unemployment in check.

2) Coronavirus Preparedness and Response Supplemental Appropriations Act: -

Through this act, the government of United States is looking to pump up to 8.3 Million US dollars into the health care sector which is aimed at keeping investment as well as consumption in check. This is because sick people will not be able to either contribute towards production, nor will they have any substantial consumption. It is aimed at improving the health care of the country and will increase the aggregate demand for goods and services by keeping stability.

3) Families First Corona Virus Act: -

The families first corona virus act is also a similar measure which has been undertaken by the government with a view to providing stability to consumption as well as production. It is aimed at reducing the tax burden on companies to ensure that investments do not suffer and at the same time provides unemployment benefits to the society at large which will help in keeping consumption in check.

Monetary Measures: -

The core monetary policy measures taken by the Federal Reserve to correct the impact of the Corona Virus pandemic include the likes of reducing the interest rates which it charges from banks to grant loans to an all-time low of 0.25% this helps the banks in granting easier loans to consumers as well as producers. The net result of this is that the consumption as well as production in the country can happen at a stable rate and the country can recover from the ill effects of the recession itself.

Aggregate Demand & Supply Changes: -

The core intention of the government is to increase the aggregate demand which in turn would affect the supply as well as prices of goods as well as services. The net outcome of all of the conditions described above in the form of graphs is as follows: -

In the graph above, we see how the government’s fiscal policy as well as the central bank’s monetary policy increases the aggregate demand for goods and services. The end result of this is that the Quantity also shifts from Q1 to Q2 while we see a rise in prices from P1 to P2 and the equilibrium shifts from E1 to E2. The equilibrium is the point where demand and supply curves meet. The supply also increases and is evident from the slope between E1 and E2 respectively as producers get cheaper loans and have lesser tax obligations which allow them to expand their business activities.

Please feel free to ask your doubts in the comments section.