In the current paper, a discussion is presented regarding the meanings and effectiveness of fiscal and monetary policies. Various economic models are practiced across the world. Free market economies have been lauded as the most effective system of operations. In the current setup, the private sector provides the means of production while the government sets up regulatory frameworks to ensure a level playing ground. Besides the government’s regulatory role, it also provides sensitive goods and services that cannot be left to the private sector for various reasons. In open market economies, two policies have been used to spur economic growth, maintain stability and attain other determined economic objectives. Fiscal policy and monetary policy are some of the approaches employed by governments to control development. To provide a comparison of the effectiveness of the policies, each is analyzed.
Fiscal Policy
Fiscal policy is an approach where a government uses taxation and its spending as tools to attain certain economic objectives. Taxation is the levying of money as payments to the governments for the consumption of various goods and services. Such regulations or directives are passed through legislative processes and assented into law by leaders of the executive. Various supreme laws have given governments powers to levy taxes. Therefore, exercise has a legal effect. Through the manipulation of taxes, governments are able to attain their economic objectives.
During a recession in an economy, governments can stimulate economic growth through changes in tax rates. Reducing the tax burden on the economy makes businesses easier to start and run. Investors will be attracted to open up in areas where taxes are low. Opening up of businesses has the potential of creating job openings or employment opportunities. Those employed are able to afford basic commodities given that their disposable incomes are improved. The economy will grow with the creation of employment opportunities arising out of the reduction in interest rates.
During economic booms, the government will contemplate an increase in taxes in order to control economic activities. An increase in taxes will reduce the prospects of the creation of new employment opportunities from new businesses. Such a mechanism is referred to as a contractionary fiscal policy measure. Hence, by utilization of taxes as tools, the government is able to achieve its desired goals in regard to economic activities.
The second tool under the fiscal policy framework by the government is applicable to spending. Expenditure in various sectors of the economy has an effect on the performance and response of microeconomic indicators. Governments spend on health, security, education and any other areas as deemed appropriate. Expenditure on infrastructure development has an effect on stimulating economic growth and activities. Investments in the improvement of roads, railway transport, airports, and security have an effect on attracting investments. Locations that are secure and readily accessible will be considered prime for investment purposes. Industries and other businesses will be created in such regions. Employment opportunities will result from such government initiatives. As a result, the government will have its economic stimulations achieved through spending programs.
A reduction of government spending in infrastructural sectors will serve to discourage investment in such areas. Investors will shy away from regions that lack infrastructure for carrying out their business. That will create a state of stagnation in economic activities. The reduction in government expenditure falls under contractionary fiscal policy measures as a response to an economic boom. The aim is to control economic performance and maintain stable inflation rates.
