Macroeconomic policy instruments


Macroeconomic policy instruments

Macroeconomic policy instruments fall within the realm of Macroeconomics policy. The latter can be divided into two subsets: a) Monetary policy and b) Fiscal policy. Monetary policy is conducted by the Federal Reserve or the central bank of a country or supranational region (Euro zone). Fiscal policy is conducted by the Executive and Legislative Branches of the Government and deals with managing a nation’s Budget.

Monetary policy

Monetary policy instruments consists in managing short-term rates (Fed Funds and Discount rates in the U.S.), and changing reserve requirements for commercial banks. Monetary policy can be either expansive for the economy (short-term rates low relative to inflation rate) or restrictive for the economy (short-term rates high relative to inflation rate). Historically, the major objective of monetary policy had been to manage or curb domestic inflation. More recently, central bankers have often focused on a second objective: managing economic growth as both inflation and economic growth are highly interrelated.

Fiscal policy

Fiscal policy consists in managing the national Budget and its financing so as to influence economic activity. This entails the expansion or contraction of government expenditures related to specific government programs. It also includes the raising of taxes to finance government expenditures and the raising of debt (Treasuries in the U.S.) to bridge the gap (Budget deficit) between revenues (tax receipt) and expenditures related to the implementation of government programs. Raising taxes and reducing the Budget Deficit is deemed to be a restrictive fiscal policy as it would reduce aggregate demand and slow down GDP growth. Lowering taxes and increasing the Budget Deficit is considered an expansive fiscal policy that would increase aggregate demand and stimulate the economy.

References

* The Harper Collins Economics Dictionary
* Principles of Economics. N. Gregory Mankiw


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