Question

Monetary Policy and Fiscal Policy

A healthy economy typically has low rates of unemployment and steady prices. Low rates of unemployment means that the economy is operating at its full potential. To ensure the economy continues to operate at potential GDP (full capacity where all savings are invested in production functions, and where all those who wish to work can find a job, and all other factors of production are fully utilized in the production function), governments use fiscal and monetary policies to lower unemployment rates and to control prices (inflation).

Discuss the primary goals of expansionary and contractionary fiscal policies and their effects on unemployment rates, inflation rates, interest rates, private investment, and GDP.

Answer 1

The primary goal of expansionary fiscal policies to boost growth to a healthy economic level.This is needed during the contractionary phase of the business cycle.The government wants to reduce unemployment, increase consumer demand and avoid a recession. If a recession has already occurred, then it seeks to end recession and prevent depression.

The two major example of expansionary fiscal policy are tax cuts and increased government spending. It puts more money into consumer's hands to give them more purchasing power. It uses subsidies, transfer payments including welfare programs and income tax cuts. It reduces unemployment by contracting public works or hiring new government workers. All these measures increase demands. It may cause some inflation but reduce interest rate which in turn increase private investment and GDP of the economy will increase.

The primary goal of contractionary fiscal policy is to decrease the amount of money available to the populace to fight inflationary pressures. Its purpose is to slow growth to a healthy economic level. As when prices rises too fast in clothing, food and other necessities, it quickly gobble up savings and destroy the standard of living.

The two major contractionary example of fiscal policy are tax cuts and reduced government spending. When governments cut spending or increase taxes, it takes money out of consumers' hands. It also happens when the government cuts subsidies, transfer payments including welfare program, contracts for public works, or the number of government employees. Shrinking the money supply decreases demand, it gives consumer less purchasing power. That reduces business profit, forcing companies to cut employment.

Elected officials use contractionay fiscal policy much less often than expansionary fiscal policy because voters don't like tax increase. They also protest any benefit decreases caused by government spending.