Monetary policy is defined as the actions that a central bank (or the bank’s bank), a board of representatives, or a regulatory committee does that determines the rate of growth and the size of the money supply in order to direct an nation’s economic objectives. In the United States our money supply is the Federal Reserve. In 1913 The Federal Reserve act was put into place, it gave the Federal Reserve the power to formulate U.S. Monetary policy. The Federal Reserve is made up of two main parts; first, there is the Federal Open Market Committee (FOMC) they are responsible for implementing open market operations, the hope by doing this is to adjust the federal funds rate, or more simply, the rate at which banks borrow reserves from each other. Second, there is the Board of Governors they look after the “discount rate”, or the minimum interest for lending to banks, and adjust the reserve requirements.

The Federal Reserve utilizes three main tools: open market operations, the discount rate and reserve requirements. The Open Market Operations are simply the buying and selling of government-issues securities. This is the main method in which monetary policy is formulated in the United States. This action makes it possible to obtain the preferred amount of reserves held in the central bank, and to alter the price of money and change currency rates. The Federal Reserve will try to increase liquidity of a security in the market, or the money supply, by buying the security from the market, which decreases the interest rate. The bad side to this is, a decision to sell the security to the market is a sign that the interest rate will increase. Too much liquidity can cause inflation, therefore increasing the demand and increasing the cost of borrowing, or interest rate. Then there is the Discount Rate, or the interest rate that banks and other depositories are charged to borrow from the Federal Reserve. There are three forms of credit: primary credit, secondary credit and seasonal credit. Each form has its own interest rate, but the primary credit is generally referred to as the discount rate. The primary rate is used for short-term loans and are usually given to banks with a more solid financial reputation. The secondary credit rate is a little higher and is given to facilities with liquidity problems or is given out in severe financial crises. Lastly, the seasonal credit is for institutions that need extra support seasonally. The last of the tools is the Reserve Requirement is how much money the banks or institutions are required to keep in their vaults, this is a fail-safe to cover their liabilities to customers. The Board of Governors decides the ratios of reserves that go under reserve regulations. The main reason for this is from past problems, many in the 1920’s, where many people lost their money because the bank loaned too much. By influencing the supply and demand cost of money, the central bank’s monetary policy affects the health of the country’s economic affairs. By using its tools, the Federal Reserve becomes directly responsible for interest rates and other related economic situations that affect almost every part of our daily lives. Fiscal Policy is the close cousin to monetary policy. The two policies are used in many different combinations and an attempt to direct the economy. In the United States Past our approach to economics was laissez-faire; we believed that the government should not interfere in commercial affairs. After the end of WWII, we quickly learned that the government had to take control to keep the country moving.

Fiscal policy is defined as government spending policies that influence macroeconomic conditions. They are the policies that affect interest rates, tax rates, and government spending in an attempt to control the economic situation. It was found out that mixing both monetary and fiscal policies that the government could do this. We had to create a balancing act. Fiscal policy comes from the theories of John Maynard Keynes, also known as Keynesian Economics. The theory creates a change in influence, then, curbs inflation and increased employment and supports a healthy value of money. The government accomplishes this by influencing macroeconomic productivity by increasing or decreasing taxes and public spending. This is where finding a balance is needed for these influences. If you increase the money supply in attempts to increase a dead economy you could actually cause inflation, because an increase in money preceding an increase in consumption can cause the value of the money to decrease, which means it takes more to buy something that hasn’t changed in value.

The government may do something known as “pump priming” its where they lower taxes, to give the population more money which will increase consumption, and the government will increase government spending by buying services from the market, such as building roads or hospitals. Paying for these services creates many jobs, lowering unemployment and building wages which all turns into an economic flow. They are essentially creating two new economic boosts in the economy. However, if there is no restriction and regulation on the process the increase in Economic productivity can easily break that very narrow boundary of too much money in the market. The excess supply decreases the value of the money and caused inflation, again it takes more to buy a product that has not changed in value. It is this reasons that fiscal policy alone that fiscal policy alone is very difficult if not impossible. The effects of fiscal policy are different for every person, depending on the political values and goals of policymakers. There could be a trickle-down economy, less taxation for the rich in hopes that they will spend more and it will multiply down to the poor, or there may be higher taxation for the poor because, people believe they can afford it. This causes a split in the population, making it more difficult to please everyone, which is why monetary and fiscal policy need to go hand and hand. Together it makes it easier to control the economy, everyone is happier and everything all around is more prosperous.

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