The United States economic system is far from perfect. Over the years there has been much development in ways to predict the future twists and turns of the economy. These predictions are not always correct by never the less we need to make adjustments to influence our macroeconomic outcomes. We typically have three systems that we rely on to make our decisions: monetary policy, fiscal policy, and long run growth. Each of these systems has their pros and cons, but I believe that is the most optimal choice and after I present the facts I think that you will see that too.
Let’s start with fiscal policy. Fiscal policy determines the way in which the central government earns money through taxation and how it spends its money. To assist the economy, the government will cut tax rates while increasing its own spending. To cool down an overheating economy, the government will raise taxes and cut back on spending. There are several pros for fiscal policy but there are also several cons. First, we can direct spending to specific purposes. Unlike monetary policy tools which are general in nature, we can direct spending toward specific projects, sectors, or regions to stimulate the economy where it is perceived to be needed the most. We can also use taxation to discourage negative externalities.
By taxing those who overuse limited resources can help to remove the negative effect they cause while generating government revenue, the effects of fiscal policy can usually be seen much quicker than the effects of monetary policy. A lot of people view this as helpful because we know quicker whether the changes we are making are helping are not. However, this means that if we don’t do the right changes the first time and make another change and another and another we risk destabilizing our government. Now let’s talk about some of the cons that come with fiscal policy. We can create large budget deficits. A budget deficit is when the government spends more money annually than it takes in.
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If spending is high and taxes are low for long periods of time, then our deficit will grow larger. Fiscal policy can also take money out of our local economy because tax incentives may be spent on imports. The effect of fiscal stimuli is mute when the money is put into the economy through tax savings. Government spending can be spent on imports, sending money abroad instead of keeping it in our local economy. Another con that you will find in fiscal policy and not monetary policy is that fiscal policy can be politically motivated. Raising taxes is usually an unpopular decision and can politically dangerous to implement. Although, politicians can use this to their advantage to get elected to positions of higher political power.
Now let’s look at long run growth. Now that we have talked about two of the three policies. It’s time to talk about the policy that I advocate for the most over the previous two; monetary policy. Monetary policy includes the management of the money supply and interest rates by central banks (The federal reserve system for the United States). To stimulate a faltering economy, the central bank (FRS) will cut interest rates, making it less expensive to borrow while increasing the money supply.
If the economy is growing too rapidly, the central bank can implement a tight monetary policy by raising interest rates and removing money from circulation. Monetary policy has several pros and several cons. First, the central bank can use interest rate targeting to control inflation. We know that inflation occurs when the general prices of all goods and services in and economy increases. So, small amounts of inflation are good for a growing economy, it encourages future investment and allows workers to expect higher wages. By raising the target interest rate, investment becomes more expensive and works to slow economic growth.
However, we can also use this same method to increase economic growth by lowering the target interest rate, therefore investment becomes cheaper. When increasing the money supply or lowering the interest rates this tends to devalue the local currency, but with monetary policy we use this to our advantage to boost exports. A weaker currency on world markets can serve to boost exports as these products are effectively less expensive for foreigners to purchase.
This would only hurt companies that are mainly importers, hurting their bottom line. Another way that monetary policy differs from fiscal in a positive way is that the it is politically neutral. Even if a monetary policy is action is unpopular, it can be undertaken before or during elections without fear of political repercussions. Lastly, monetary policy can be implemented fairly easily. Often just signaling their intentions to the market can yield results. But, just like the other two policies monetary policy also has some cons. There is a somewhat large risk of hyper inflation.
