Economics Essay on Active Monetary and Fiscal Policies

2021-06-02 14:16:43
5 pages
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Middlebury College
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Economics consider the attributes of the rule in the two monetary policies. These rules are the constant money growth as well as the strict inflation targeting rules. Considering the intertemporal equilibrium model having the flexible monetary prices under which the policy is active, the fiscal policy is regarded as passive. It is assumed that the fiscal decision makers take the monetary rule as provided and therefore, limit other state dynamics. This paper is a reflection of the dynamic economy considering the active monetary and fiscal policies as well as their differences.

Under the constant money growth in the economy, the active monetary policy is applicable if and only if the issuance of the public debt is under the nominal terms. This strategy permits temporary deviations of the inflation from the targeted point to react to the shocks if there is a scope for revaluation(Sanchez, 2010). Many countries inclusive of the United States use the active monetary policy under which the central banks evaluate the present situation, assesses the future economic course and react with appropriated policy actions. To comprehend the active policy it is critical to differentiate it from the passive.

About the active monetary policy, the central bank committee applies its discretion in reaction to the changing situations of the economy. This act implies that this financial institutions may decide to act or not depending on the evaluation of the countrys economy. This strategy is different from the passive which involves set of guideline dictating the policy actions(Sanchez, 2010). Examples of the policy tools used in the active type are the adjustment of reverse requirements for the financial institutions, open market operations, changing the short-term interest rates that are charged for the overnight loans as well as the Federal Funds Rate(Chen, 2014) . This tool is used to grant discretion and flexibility by the policy makers if inflation exceeds the anticipated levels.

Regardless of their benefits, some of the economists like Milton Friedman stated that this tool depended intensively on the judgment of the central bank and significant adjustments could raise more economic problems because of the vulnerability of the policy to political pressures(Chen, 2014). However, this strategy has succeeded in its objectives in countries such as the United States if there is no intervention of the politicians.

On the other hand, the fiscal policy refers to the techniques used by the government to adjust the tax rates and expenditure to bring back the economy to its norm. Most of the times, the government spending and taxation levels rise steadily from one fiscal period to the next. During this periods, people earn their incomes, decide about their investments and savings and so on. Under the passive policies the government allows the current policies to be unchanged because of stability. However, under the active fiscal policy, the policy makers adjust these attributes to change the economic condition through tax rates to adjust the investment levels and federal expenditure for the aggregate demand of goods(Chen, 2014). For example, the expansionary active fiscal policies may increase the demand of goods by increasing the government expenditure if the country experiences slow growth in the short run. The following graph reflects the change.

Some of the economist have argued that active fiscal policies are not effective in restoring the economy back to its growth. However, there are different circumstances when these strategies are needed. For instance, China has experienced stagnated growth in the past five years (Rogalska, 2012). What the country requires currently, is the demand adjustment. It is critical for the government to apply a more active fiscal policy. It has to include the off-budget spending, specifically, which depends on the revenues derived from land sales, as well as, increasing the expenditure on the quasi-government agencies. Fiscal expansion can assist the government in achieving some of the objectives set. However, from the existing evidence, the active monetary policy is effective in the short run to adjust the economic situation.

Increasing Government Spending to Control Recession

The expansionary fiscal policy comprises of the attempts by the government to increase its spending or lower its taxes. The increase in expenditure results to the growth in aggregate demand because AD=C+I+G+X-M and therefore, leads to economic growth (Rogalska, 2012). The amount increased in the budget can be derived from the external and internal loans, and lowering of taxes to motivate people to demand more goods and services as reflected in the equilibrium equation.

Regardless of the notion that increased government expenditure can reduce recession in the economy, some of the economics are against the policy because of its potential to generate stagnated growth. Research studies show that expansionary fiscal policy especially, increased spending can cause the crowding out effect (Rogalska, 2012). This strategy implies that the central bank will have to acquire loans from the private sector causing them to spend less, and as a result, there will be no increase in the aggregate demand. If the economy is almost close to the full production capacity, increased spending may result to inflation.

The proponents of the former president of the United States $ 787 billion stimulus bill persisted that the significant bailout by the government played an important role in taking the economy from recession. However, they assumed that with no expected destructive actions by the government, the self-correction mechanism was anticipated to take the economy out of the prevailing situation as experienced in 2009 (Riedl, 2012)

The President Obamas strategy failed through its own ways. According to the 2009 economic report by the White House, it was predicted that the economic stimulus program through increased government expenditure would generate 3.3 million jobs in the economy. However, by the end of 2010, the condition was different because the country lost approximately 3.5 million jobs, this pushed the rate of unemployment above 10%. This condition did not happen in Obamas era only but in other countries as well as administrations. For instance, in the 1990, Japan reacted to the economic recession through the enactment of the 10 stimulus programs, but the economy continued to experience stagnated growth. Also, the New Deal Lawmakers increased the federal expenditure by 100% in the 1930s, but the unemployment rate was high until the Second World War (Riedl, 2012)

From the analysis above, it is clear that increasing the government expenditure to counter the effects of recession can work out as expected. However, from the evidence provided, this strategy has failed to meet its objectives in various situations making it difficult for the governments to control stagnated growth. In future, it is critical for the key financial institutions to impose other fiscal and monetary policies to take the countries out of recession.


Chen, S. (2014). Fiscal and Monetary Policies in a Transactions-Based Endogenous Growth Model with Imperfect Competition. Japanese Economic Review, 66(1), 89-111., B. (2012). Why Government Spending Does Not Stimulate Economic Growth: Answering the Critics | The Heritage Foundation. The Heritage Foundation. Retrieved 13 February 2017, from


Sanchez, M. (2010). The interplay of monetary and fiscal policies in a multinational currency union. International Journal Of Monetary Economics And Finance, 3(1), 33.

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