The Impact of Monetary and Fiscal Policy
Introduction
The Great Depression represents a global phenomenon that instigated economic recession that affected many countries. The phenomenon particularly affected the economy of the United States during the 1920s and 1930s. As such, the shrinking of the American economy during the periods demonstrated the need for an expanded federal government capable of formulating monetary and fiscal policies to mitigate the effects of economic recession. Indeed, fiscal and monetary policies sustain progressive economic growth, foster full-employment, and reduce inflation. Notably, fiscal policies include government spending, as well as taxation. In this case, the federal government sustained a higher government spending and imposed taxes on the wealthy individuals during the recession. Monetary policies, on the other hand, involve influencing the forces of demand and supply of goods and services through interest rates and social security for the elderly. Notably, the federal government relied on the monetary policies to curb the inflation rate during the Great Depression. During the economic recession caused by the Great Depression, the federal government employed a mix of monetary and fiscal policies to initiate economic recovery.
Social Security Policy
Social security represents a notable example of a monetary policy that addressed welfare needs of consumers during the economic recession of the 1920s and 1930s created by wealth and unemployment shocks. The Federal Reserve is an institution tasked with the responsibility of monitoring the U.S.’ money supply. Hence, the Federal Reserve is involved in setting social security fund target rates issued to the vulnerable members of the population. These funds are utilized by the vulnerable members to improve their wellbeing.
According to Fishback (2010), the Great Depression transformed the role of the federal government in the economy. In this manner, the federal government took over the responsibility to improve the welfare of the elderly people through the creation of social security policy. The social security fund mitigated the perceived welfare losses caused by the high unemployment rates in the American economy. Peterman and Sommer (2018) contend that elderly persons were adversely exposed by the welfare shocks because their post-retirement consumptions were pegged on personal savings and investments. Horowitz et al. (2009) aver that private investments for the elderly had already collapsed in the housing bubble. The social security funds, therefore, reduced the exposure of the elderly to welfare shocks characterized by a struggling economy. Social security helped during the great Recession because the program empowered the elderly to purchase basic necessities such as food and clothing.
Interest Rates
Charging high interest rate is a notable monetary policy that was used by the federal government to help stabilize the economy during recession. Smiley (n.d) agrees that the Great Depression was not only felt in the United States, but also other nations in Europe and Asia. According to Smiley (n.d), by 1928, the economies of Germany, Brazil, and Southeast Asia were declining. Smiley (n.d) further reports that the economies of Poland, Argentina, Canada, and the United States were contracting by 1929. The sole factor that tied all the mentioned countries together was the international gold standard that prevented the nations from increasing the amount of paper money in circulation (Carabelli & Cedrini, 2014). In an attempt to prevent the economy from shrinking, the Federal Reserve System raised the interest rates charged by commercial banks on loans. The intention of hiking the interest rates was to curtail the outflow of American gold to other countries. Per Carabelli and Cedrini (2014), the decision to raise interest rates enabled the United States’ economy to receive shipments of gold from other countries. Smiley (n.d) further reports that the hiking of interest rates made other countries to lose gold to the United States. Sennholz (2009) reports that the reserve balances rose from 2.9 billion in January 1934 to 14.4 billion dollars in January 1941. The injection of gold standards boosted the American bank reserves to unprecedented levels and was converted to monetary currencies issued to the American citizens in form of loans. The loans moderated the adverse effects of the economic recession because the Americans had the funds to spend on consumer goods and services.
Federal Government Spending
Government spending is a fiscal policy that helped to mitigate the great recession. Recessions are often caused by a decline in aggregate demands of commodities occasioned by a fall in consumption or lack of investments (Carabelli & Cedrini, 2014). To encourage aggregate demand of commodities during the economic recession, the federal government under the leadership of Hoover and later Roosevelt initiated spending with the intention of increasing the income and wealth of the people responsible for aggregate demand. The increased government spending worked during the Great Depression because certain resources like land were not fully exploited. Since the economy was operating under capacity, government spending sought to support the agricultural sector of the economy to instigate growth. In this way, government spending sought to produce more commodities, as well as increase consumption.
During economic recession, national governments should operate on deficit spending to make up for the decline in investment and boost commodity consumption to stabilize aggregate demand. Hoover’s administration initiated a raised government spending that operated on budget deficits. Carabelli and Cedrini (2014) argue that budget deficits resulted from a decline in tax revenues. Similarly, Roosevelt’s administration initiated the New Deal to stabilize the economy. With regard to fiscal policy, the federal government moved away from budget balance to a more aggressive spending. The increased government spending was also funded by budget deficits. Fishback (2010) argues that budget deficits have multiplier effects. That is, for small deficits to yield maximum impacts in a large economy, the multiplier effects, such as full-employment, should be maintained at optimum levels. The spending on the agricultural sector generated few jobs, thus signifying slow economic growth, which dragged the return to full employment. Even though operating on budget deficit led to gradual economic recovery, established companies capitalized on improved consumption to generate substantial profits, which were utilized to revamp their operations.
Government spending during recession does not displace private investments within the economy. Therefore, to mitigate the economic recession experienced during the 1930s in the United States, the government needed to create jobs, as well as prevent wasteful use of resources. The jobs in the different sectors of the economy are to be created exclusively through favorable government spending. Horowitz et al. (2009) contend that, in normal situation, large budget deficits stifle private investments; thus, it is important to include long-term investment initiatives alongside consumption. The investment in long-term assets like education and infrastructure may likely generate more revenues for a government (Horowitz et al., 2009). This makes it possible to pay sustained debts in the future, as well as increase aggregate demand for goods and services as more resources will be deployed in the economy. Thus, government spending and investment are significant factors capable of mitigating recession if they are utilized efficiently.
Taxation
Expansionary fiscal policy in the form of taxation helped to mitigate the prolonged recession. During recessions, spending is often equated to investments. Carabelli and Cedrini (2014) aver that when federal governments increase spending, the funds are perceived to be generated from taxes remitted by the people. Taxes are imposed on people by the government to yield more revenues to enable the latter to support its spending agenda. However, taxes may encourage hording of cash by people. For example, the 2-cent tax imposed on cheques between 1932 and 1934 prompted households to shift towards holding money in usable currencies (Smiley, n.d). Parts of the money hoarded by American citizens were spent on household goods while the rest were invested in housing units (Horowitz et al., 2009). In the United States, during the American economic recession, regulation of businesses embodied in the New Deal imposed and removed some taxes. According to Horowitz et al. (2009), the New Deal was a set of programs enacted by Roosevelt’s presidency to address the economic catastrophe created by the Great Depression. The New Deal entailed broad array of taxes imposed on people and businesses to generate revenues for government spending. For example, Roosevelt’s administration attempted boosting revenue by initiating a Revenue Act in 1932 to tax the rich. However, Smiley (n.d) believes that huge taxes imposed on people may not support economic recovery during contraction. Peterman and Sommer (2018) also opine that high taxes reduce a household’s disposable income, thereby curtailing household spending. Consequently, this jeopardizes the quest for economic recovery. However, the case of America was unique because the New Deal exempted the poor and low-income earners from hefty taxes. Tax exemptions increased workers’ disposable incomes. Per Sennholz (2009), tax exemptions boost individual and business activities. On the other hand, low taxes imposed on start-up businesses increased after-tax cash flows that were utilized to expand business activities or invest in new ventures.
Progressive taxes imposed on the rich helped to mitigate the great recession. However, Carabelli and Cedrini (2014) contend that progressive tax rates imposed on wealthy individuals cannot be injected into the economy. This claim is refuted by Fishback (2010) asserting that 47 percent of people not paying tax in the United States include; the elderly, disabled, and low-income earners. A tax increase for individuals would be insignificant in boosting the revenues of the nation. Hence, imposing taxes on the poor uniquely works to make them poorer and disheartens them from seeking for jobs. Notably, even if they find jobs, the revenues generated by poor individuals would not produce significant differences in regards to economic recovery during the Great Recession. Hence, Roosevelt’s administration imposed taxes on the rich to support his spending initiatives that worked to stir economic recovery.
Conclusion
Fiscal and monetary policies supported the federal government in addressing the economic recession that resulted from the Great Depression. The social security instituted during the Great Depression empowered the people, including the vulnerable members of the population, to purchase goods and services. The consumer spending subsequently boosted businesses to generate more jobs in the economy. The increase in the interest rates also aided the economy by eliminating the hoarding of cash and investment in the housing bubble that may have caused massive inflation in the economy. In addition, the initiation of aggressive government spending helped the economy to grow in different sectors. This allowed the government to create more jobs and support infrastructural development, which is essential in economic recovery and growth. The progressive tax imposed on the wealthy also generated adequate revenues to support the federal government’s economic recovery agenda.
References
Carabelli, A., & Cedrini, M. (2014). Keynes, the Great Depression, and international economic relations. History of Economic Ideas, 22(3), 105-135.
Fishback, P. (2010). U.S. monetary and fiscal policy in the 1930s. Oxford Review of Economic Policy, 26(3), 385–413.
Horowitz, S., Boettke, P., Reed, L., Allison, J., & Foundation for Economic Education, inc. (2009). The house that Uncle Sam built: The untold story of the great recession of 2008. Irvington-on-Hudson, N.Y: Foundation for Economic Freedom.
Peterman, W., & Sommer, K. (2018). How well did social security mitigate the effects of the Great Recession? Federal Reserve Board. Retrieved from http://williampeterman.com/pdfs/social_security_ier_final_submit_superclean.pdf.
Sennholz, H. (2009). The Great Depression. Mises Institute. Retrieved from https://mises.org/library/great-depression.
Smiley, G. (n.d). Great Depression. The Library of Economics and Liberty. Retrieved from https://www.econlib.org/library/Enc/GreatDepression.html.