Expansionary Economic Policy
Expansionary policies are macroeconomic measures applied by the government to instigate economic growth and development. One of the goals of the policies is to increase the supply of money in the economy through government spending and tax reduction; in order to woo investors to commit their funds in establishing businesses in the country. This will creat job opportunities to the population. Therefore, the state experiences growth and economic expansion. Increase in business activities lead to increased competition, an action that exposes the consumers to fair prices. These prices are competitive in nature hence people access basic products they need in their lives. This essay discusses the efforts by the government to move the economy out of recession by engaging in expansionary economic policies. Specifically, the issues to talk about include taxes, government spending, aggregate demand, GDP and employment.
In this section, government interventions will be outlined in details to ascertain the best policies to be implemented. An economic recession is a phenomenon in the market where activities are halted due to low money supply. Prices of goods and services rise above the normal level, a situation regarded to as inflation. The scenario is detrimental to a country’s economic welfare. When inflation sets in, the government need to find ways to deal with the situation. This includes engaging in expansionary fiscal policy by changing the level of spending and taxes.
Taxes and Government Spending
Spending by government includes expenditure through consumption, transfer payment and investment. These spending are financed through taxes, seigniorage and borrowing from international financial institutions. Increasing the level of spending have a positive effect on aggregate demand. Consumption on the other hand increases as people have enough money to spend in purchasing goods and services. The shifting of money from the private sector to the public sector opens up unproductive sections in the economy. An example of government expenditure includes spending (international monetary funds )IMF loans on road infrastructure (Cacciatore, Fiori, and Ghironi 100). The sourcing of raw material may be carried out internally to encourage local traders to work with the government as well as aid the economy to grow.
Infrustructural development takes the largest share in government spending. The following effects emanates from spending. First , aggregate demand is deemed to rise due to increase in the amount of money in circulation. Employment opportunities for the youths as well as the entire population increases because government projects require massive labor. This labor is sourced from the public. The gross domestic product (GDP) is also affected by government policies. Aggregate goods and services produced within a country increases because money is pumped into the economy.
Economically, increase in supply causes a rise in demand and price reduction. Increasing taxes on imported goods decreasing the amount of foreign products sold in the country. Therefore, local traders will take advantage of the trade barriers to expand their businesses. This improves the country’s welfare while utilising the natural resources. On the other side, reducing taxes imposed on local industries helps develop different sections in the economy. It may include giving subsidies to entrepreneurs as a way of creating employment. Companies will increase their production levels, an action that renders trading efficient because of market expansion. The federal reserve bank is tasked with the administration of monetary policies when dealing with inflation. These policies are economically driven because the factors involved affect the selling and buying of products as well as money supply (Wang and Dor 150).
The Federal Reserve Bank (The Fed)
The federal bank is the overall controller of the states finances in a country. It is the regulator of all banks existing within the boarders of any country in the world. Its work is to advice the government on various issues concerning the use and borrowing of money. Collecting and accounting of funds obtained by the state is left in the hand of this institution. Foreign banks and transactions that touches on the government must go through the central bank. Therefore, it authorizes the payment and receiving of money from various sources. In addition, it advices the nation in cases where huge amount of money is involved to ensure that it spends wisely. The local governments on the other hand seek advice for budget preparation and execution of money allocated to spearhead the development projects (Hetzel 127).
The fed utilises three main actions/tools to monitor the circulation of money in the economy. These tools include reserve ratio, discount rate and open market operations. Reserve ratio refers to the minimum funds required to be deposited to the federal bank by the financial institution in the state. Raising the bar or increasing the minimum amount that commercial banks deposit with the central bank reduces money supply in the economy. Therefore , the lending activities will go down an action that affects investments activities for individual clients and corporate businesses. Commercial banks will also desist from financing long term projects. The interest rate charged on loans discourages people from borrowing from the commercial banks. This means that a lot of projects will stop functioning due to high cost of borrowing. The economy grows at a very slow pace hence increasing the cost of production. The general prices of goods manufactured by local firms goes up within the short run period. Consumers have to cut their spending in order to meet their basic needs.
Contrary, reducing the ratio has positive effects to the economy. Lending services increases money supply. Many traders access cheap loans for running their designated projects. Governement is able to increase its revenues by using the tax collected from business people and companies (Wang and Dor 151). The second tool is discount rate applied by fed bank in lending money to commercial banks. The increase in discount rates encourages financial instituitions to borrow huge amount of money from central bank. This money will be exposed to consumers as loans. Huge discount insinuates that financial instititutions will apply low interest rate when lending money to customers. This means that the country will benefit from increased economic activities. Imposing low discount rates by federal bank results to low borrowing by financial institutions an action that raises the interest rates. Therefore, activities associated with borrowing of funds from the organisation/company appear at the lower level.
The third tool is open market operations. It is a government initiative for borrowing money from the public or local banks. Investors are invited to buy government bonds and securities in exchange for money. This money is used to finance government initiated projects that are long term in nature. Investors will benefit from dividends paid by the local government. Moreover, they still retain their initial investment or capital. This transaction takes place in a number of steps. First, government announces and invites people to subscribe for shares. They give certificate for the number of shares held.
The proceeds of this endeavor are channeled to various projects that the state wants to achieve within the stipulated period. Thus, government will have enough money to spend to advance its plan. One advantage of this source of funding is that the state borrows funds at no interest rate instead it offers bond/securities as corrateral (Wang and Dor 150). Interest rates contribute to the total cost of borrowing. Money borrowed from the local market is injected into constructive projects that spearhead the development of infrastructure. The local community is more concerned with government spending habits hence demands accountability. This means that local leaders will behave and act in accordance to the laws and regulations set out in the constitution. In addition, government or federal spending increases investor’s confidence that their projects will sail through due to government goodwill (Crafts 270).
In conclusion, expansionary policies are geared at the elimination of inflationary or recession effects. A recession is a state of economy where activities geared at generating income for the country as well as individual citizens decline tremendously. This phenomenon occurs through some processes that need to be dealt with before solving the problem. Some of the factors involved carry with them the monetary value while others require the administration or government intervention through policy making. The imposition of tariffs by the government denotes political goodwill or restriction for Investment by individual foreign players. Monetary or fiscal policies are concerned with the administration and monitoring of finances in public domain. If there is a lot of money in the market, the economy is deemed to suffer inflationary problems because the value of money goes down.
Cacciatore, Matteo, Giuseppe Fiori, and Fabio Ghironi. Market Deregulation and Optimal Monetary Policy in a Monetary Union. 3rd ed. Cambridge: National Bureau of Economic Research, 2013. Print.
Crafts, Nicholas. “Returning to Growth: Policy Lessons from History*.” Fiscal Studies34.2 (2013): 255-282. Print.
Hetzel, Robert L. The Monetary Policy of the Federal Reserve: A History. 2nd ed. Cambridge: Cambridge UP, 2009. Print.
Wang, Peijie, and Eric Dor. “How Do Exchange Rates Move Following an Expansionary Monetary Policy?” SSRN Electronic Journal 22.2 (2013): 123-160. Print.