Among the many strategies used by a government to maintain economic stability in times of crisis are monetary and fiscal policy. Although the preferred course of action is still up for debate, both of these tactics have been demonstrated to be successful in controlling financial crises.
Monetary Policy
Central banks oversee the money supply and interest rates as part of monetary policy. The central bank typically lowers interest rates to promote borrowing and expand the money supply in an effort to boost a faltering economy. When economic expansion is too brisk, the central bank will raise interest rates while removing money from circulation, preventing future expansion (Stein, 2012).
Fiscal Policy
Fiscal policy determines the ways in which the government earns (through taxation) and spends its money. To increase economic growth, the government will reduce the tax rates while increasing its spending, and to counter rapid economic growth, it will increase the tax rates and cut down on spending (Afonso & Sousa, 2012).
Advantages and Disadvantages
Both of these measures have their advantages and disadvantages, which makes it difficult to decide on the most effective of the two. Monetary policy is likely to have a significant effect on stabilizing the economy compared to fiscal policy as central banks are independent and not affiliated with any political party. As such, changes to the economy can be made quickly and when required as political issues do not interfere in the decision-making process. Fiscal policy, on the other hand, is highly influenced by politicians as it focuses on altering tax rates and government spending patterns, which is part of the mandate of the politicians. Monetary policy has also been criticized as its effects are general, and may not be useful when there is a need to target specific economic activities. Also, the effects may not be immediate. Fiscal policy, however, can be focused on specific industries and may increase or reduce economic growth depending on the present issues, thereby influencing economic outcomes in a relatively short duration.
In my opinion, fiscal policy is a better measure of controlling economic outcomes by governments as compared to monetary policy. A major advantage of fiscal policy is the fact that it can be used to target specific industrial sectors, thereby increasing or limiting the economic activity in that particular industry. Different industries contribute differently to economic outcomes in a country due to influence from both local and international factors. As such, the government should focus on implementing control measures to economic sectors based on the current development in the industry as opposed to universally applying the same strategies. Furthermore, using fiscal policy, the government can regulate negative effects of economic activities such as pollution by increasing taxes on such activities. Reducing taxes on specific activities can also encourage growth, for instance in agricultural and health sectors. This way, the government can have better control over the economic growth and development of the country. Although fiscal policy has several shortcomings such as political interference and the risk of creating budget deficits, most of these challenges can be prevented by increasing collaboration between the political and economic branches of the government and carefully assessing the strategies before implementation. Economic crises are usually closely linked to political outcomes of a country, and a lack of collaboration between the two disciplines may not provide a sustainable solution to the issue. Consequently, it is important that professionals from both disciplines work together to address such issues, which may not be possible in the case of monetary policy.
Increased Government Spending to Fight Recessions
Recessions are characterized by extremely low rates of economic growth that present challenges to the overall economic development of a country. Typically, real interest rates during a recession are significantly higher as the demand is too little to match the supply. As a result, private households and commercial firms react by reducing their spending practices and production respectively, causing a decline in economic growth. In such cases, the government can increase its spending to create a demand in the market, thus stimulating economic growth and alleviating the negative effects of the recession. Such a strategy may also be complemented by reducing interest rates to encourage borrowing and investment.
Challenges of Increased Government Spending
However, recent studies have shown that increased government spending may not result in the expected decline in the recession due to several factors (Kuester, 2011). First, increasing government spending can easily result in an increase in inflation in the country. Higher spending by the government means that there is a higher demand for goods and services from industries created by the government. Similar to higher demand caused by private households, the firms are required to produce more, workers work longer hours, and the firm uses its capacity to produce more intensively. Consequently, wages and production costs increase, requiring the firms to set their prices higher despite the ongoing recession.Government spending to offset the effects of recession is also faced with the challenge of "crowding out". This term refers to the process through which private investments decline as a result of increased government investment (Furceri & Sousa, 2011). Crowding out can occur in several forms. For instance, when the government increases its spending, it may have to borrow funds to an extent that it absorbs the lending capacity of the country's economy. This leads to a rise in the interest rates as private investors cannot access money for investment. A decline in private investment in the economy eventually causes a further decline of the economy, reduces revenue from taxes, and increases the government's need to borrow more money. Theoretically, this leads to a vicious cycle of borrowing and crowding out, and in the end, the effects of inflation are not reduced by government spending.
Conclusion
In my opinion, government spending to offset the effects of a recession is not a viable economic strategy. Given the effect of government spending on the private sector, such a measure is less likely to result in positive economic outcomes in the face of drastic economic decline. Private companies play an important role in economic growth and also contribute a significant proportion of the revenue collected by the government through taxation. As a result, the government should consider adopting strategies that put these factors into consideration. An example of such a solution includes combining monetary and fiscal policies at different levels to stimulate economic growth. For instance, the government, through the central bank, can lower interest rates to facilitate borrowing by private investors, while at the same time forming partnerships to facilitate investments. This way, both the government and the private investors contribute to economic growth that is beneficial to both parties.
References
Afonso, A., & Sousa, R. M. (2012). The macroeconomic effects of fiscal policy. Applied Economics, 44(34), 4439-4454.
Furceri, D., & Sousa, R. M. (2011). The Impact of Government Spending on the Private Sector: Crowding‐out versus Crowding‐in Effects. Kyklos, 64(4), 516-533.
Kuester, K. (2011). The effectiveness of government spending in deep recessions: a New Keynesian perspective. Business Review, (Q3), 14-20.
Stein, J. C. (2012). Monetary policy as financial stability regulation. The Quarterly Journal of Economics, qjr054.
