Fiscaland Monetary policy used by the government
Reducinggovernment spending alone is not enough in contracting and expandingan economy. Government spending is just but one of the fiscal tool inregulating the aggregate demand. Hence, in regulating the aggregatedemand, the government uses both fiscal and monetary policies.
Fiscalpolicy is associated with government expenditure and revenuecollection while monetary policy is associated with money supply thatis regulated with interest rates and bank reserve requirements[ CITATION Har101 l 1033 ].The aggregate demand of a countryvaries from time to time. There is need for government interventionin controlling the expansion and contraction of this level of demand.For instance there is three period in demand namely recession,overheated and recovery. Under recession period, the fiscal policywill increase the government spending and lower the taxes.Additionally, there is a period of overheated expansion. Under thisperiod, the kind of fiscal policy that is employed is that ofcontractionary. The policy attempt to increase the taxes whilelowering the government spending.
Governmentsspending entail the purchase of goods and services by the government.Government spending acts as a fiscal policy because of its potentialof rising or lowers the GDP.
Changesin taxes affect the income of consumers, which in return affects boththe consumption and the real GDP.
Monetarypolicy is the change in money supply and interest rates to expand orcontract aggregate demand[ CITATION Joh002 l 1033 ].The government will tend to increase the money supply and lower theinterest rates during regression period. However, during theoverheated period the government will lower the money supply andincrease the interest rates.
Impactof fiscal policy and monetary policy on important variables
Duringthe recession period, the level of unemployment is high. At thisperiod, fiscal policy tends to increase government spending at thesame time lowering the level of taxes in attempt to create jobopportunities. At the same time, the government tries to increasemoney supply and decrease interest rates at this period to encouragepeople to spend. As more people spend, they tend to expand theirbusiness, which in return creates employment.
Impacton interest rates
Duringthe recession period, the government will use expansionary policy tostabilize the interest rate. If the supply of money is high, thepolicy can raise the interest rates to reduce money supply.Consequently, if the supply of money is low, the policy can lower theinterest rates to increase the supply of money.
Impacton gross domestic product
GDPis affected by the government expenditure as a fiscal tool policy. Asthe government purchases goods and services, the expenditure affectsother business who sells those goods and services[ CITATION Tay001 l 1033 ].The process stimulates the GDP as theconsumers spend the paychecks they earned from the business dealswith the government.
Impacton government revenue
Ifthe government wants to increase its revenue collection, it willreduce its expenditure and increase its taxes. When demand is high,the government can step in and reduce its expenditure to lower thedemand. It can as well increase taxes to reduce disposable income forpeople and other business corporations.
Harris,Benjamin H. (Brookings Institution) Journalof Economic Perspectives:Vol. 24 No. 4 (Fall 2010)
JohnB. Taylor , Robert Raymond Reassessing Discretionary Fiscal Policy,”Journal of Economic Perspectives, 14(3): 21–36 (2000) Taylor,John B. (Stanford U) Journalof Economic Perspectives:Vol. 14 No. 3 (Summer 2000)