Fiscal and Monetary Policy

What are the general goals of Fiscal and Monetary policy?

• Cycle Moderation: To dampen the extreme booms and busts of the natural business cycle.

• Stability Targets: Maintaining stable inflation rates, protecting the domestic currency's purchasing power, and minimizing unemployment.

What are the tools of Fiscal Policy?

• Controlled By: The legislative and executive branches of government.

• Spending Margins: Increasing or decreasing state spending on public infrastructure, defense, and social programs.

• Taxation Rates: Adjusting income, corporate, or capital gains tax rates to manage consumer disposable income.

What are the tools of Monetary Policy?

• Controlled By: The independent Central Bank.

• Interest Rates: Adjusting the discount rate to change the cost of borrowing for commercial banks.

• Reserve Requirements: Altering the fraction of deposits commercial banks must legally hold in their vaults.

• Open-Market Operations: Buying or selling government bonds to directly contract or expand the total money supply.

Why are most Central Banks independent from the rest of the government?

• Short-Term Temptation: Politicians face a strong temptation to slash interest rates and pump cheap cash into the economy right before an election to artificially boost growth.

• Inflation Prevention: Central bank independence insulates monetary policy from election cycles, ensuring cash flows are guided by long-term data rather than short-term political goals, preventing hyperinflation.