Monetary Policy
Monetary policy is the action taken by the Federal Reserve to achieve specific economic goals. The main targets are the inflation and the unemployment rate. Some of the tools used to achieve the goals are open market operations, the reserve requirement and the discount rate. The policies the Fed adopts can either be contractionary or expansionary. It uses contractionary tools to when the economy is facing inflation and some of the actions taken include raising the interest rate and buying bonds from the public through open market operations. On the other hand, the Fed uses expansionary policies to prevent a recession and bring down the unemployment rate. The monetary policies affect aggregate demand through alteration of the money supply. When more money is available and interest rates are low more goods and services are demanded and vice versa.
Fiscal Policy
Fiscal policy is the alteration of government spending and taxation to spur economic growth or slow down the economy when there is inflation. Similar to Monetary policy, the Fiscal policy takes two forms which are expansionary and contractionary. Expansionary policy, which is mostly used, involves an increase in government expenditure or a cut in taxes, or both to spur growth in the economy. Contractionary policies are not common as not many economists advocate for slowing down the economy. However, during periods of serious inflation, the government can reduce expenditure and increase taxes. Fiscal policies affect aggregate demand through the multiplier effect. Expansionary policies increase aggregate demand while contractionary policy reduces it.
Challenges in Implementing Monetary and Fiscal Policy
One of the major challenges experienced when implementing both the monetary policies is balancing between inflation and unemployment. There exists a negative relationship between inflation and unemployment. Therefore, the relevant stakeholders have to decide the acceptable rate of inflation when the goal is to create employment.
