A Delicate Economic Dance
By Mark Wendell
The United States economy consists of millions of people engaged in many activities –
buying, selling, trading, computing, doctoring, teaching, manufacturing, etc. Intersecting
these activities is a central bank of the government, The Federal Reserve, who implements
their mandates to achieve certain predefined economic goals. Simultaneously, government
legislative actions in Washington endeavors to achieve their political economic agenda.
The objective of these coalescing stratagems is to prudently apply constant fine tuning
operations to find economic balance for the benefit of all who live and work in the USA. To
this end, the government employs an ongoing combination of fiscal policy and monetary
policy to manage the economy. Monetary and fiscal policies affect each other, and the right
policy mix will ideally achieve desirable macroeconomic outcomes such as price stability,
credit availability, economic growth and financial stability.
What is Fiscal Policy: Fiscal policy activities primarily involve legislative actions that
encompass government borrowing and spending policies to influence macroeconomic
conditions. Through fiscal policy maneuvers, regulators attempt to improve unemployment
rates, control inflation, stabilize business cycles, influence interest rates, and establish tax
policy. To illustrate how the government could try to use fiscal policy to affect the
economy, the government might lower tax rates to try to fuel economic growth or to
stimulate inflation. If people or companies are paying less in taxes, they have more money
to spend or invest. Increased consumer spending or investment could improve economic
growth. Also the government might decide to increase its own spending – by building and
repairing highways or by increasing military spending, thereby creating jobs and lowering
the unemployment rate.
What is Monetary Policy: Monetary policy consists of the actions of The Federal Reserve,
who determines the size and rate of growth of the money supply, which in turn affects
interest rates. Monetary policy is also implemented through actions such as directly
modifying their interest rate, buying or selling government bonds, and changing required
bank reserves. Expansionary monetary policy increases the money supply in order to lower
unemployment, boost private-sector borrowing and consumer spending. Contractionary
monetary policy slows the rate of growth in the money supply or outright decreases
the money supply in order to control inflation. Contractionary monetary policy can slow
economic growth, increase unemployment and depress borrowing and spending by
consumers and businesses. Unconventional monetary policy includes quantitative easing,
the purchase of varying financial assets from banks. The effect of quantitative easing is to
raise the price of securities, therefore lowering their yields, as well as to increase total
money supply. Credit easing is a related unconventional monetary policy tool, involving
the purchase of private-sector assets to boost liquidity. Another contractionary policy
involves the liquidation of acquired assets, the opposite policy of quantitative easing.
Finally, signaling is the use of public communication, such as a promise not to raise interest
rates, to ease markets' worries about policy changes.
The Federal Reserve and Congress are independent, that is, there is a separation of
monetary policy from fiscal policy since politics always plays a role in fiscal policy. The
Federal Reserve has what is commonly referred to as a "dual mandate": to achieve
maximum employment (about 5% unemployment) and stable prices (2-3% inflation). In
addition, it aims to keep long-term interest rates relatively low. Its core role is to be the
lender of last resort, providing banks with liquidity in order to prevent bank failures and
panics. In this role, it lends to eligible banks at the so-called discount interest rate, which in
turn influences the Federal funds rate, the rate at which banks lend to each other. Both of
these interest rates influence rates on everything from savings accounts to student loans,
credit cards, mortgages, CD’s and corporate bonds.
Fiscal policy and monetary policy are two major drivers that contribute to our nation’s
economic performance and health. Careful prescriptions of both economic functions are
required to simultaneously and majestically perform an ongoing delicate economic dance
to achieve optimum macroeconomic balance. Both policies are judicially applied to try to
boost a flagging economy, maintain a strong economy or cool off an overheated economy.
(Source: portions of this article are excerpted from www.investopedia.com)
Copyright © Mark Wendell 2017 All Rights Reserved
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