ECO203 Final Essay Example | Topics and Well Written Essays - 1250 words

ECO203 Final - Essay Example These would affect the other economic variables which include Aggregate demand, Gross Domestic Product and Employment of a country. The Government would go for an Expansionary Fiscal policy in times of recession in which U.S. Government would spend more than they would collect taxes from the people. That is government spending would exceed taxes. The opposite would happen in case of a Contractionary Fiscal Policy where the government would increase the taxes more than it intends to spend. Now government spending may account for a variety of activities which include roads, education, healthcare, welfare activities and defense. This government spending is financed chiefly by taxation (Blanchard, 2010). There are other alternative ways of funding like printing money, external borrowings from foreign countries etc. The government may also borrow from the public which is called public debt. But this would be done by the government only when on the occasion of a deficit in the government b udget. The U.S. Government utilizes the Fiscal policy in the endeavor to affect the aggregate demand along with full employment. When there is inadequate aggregate demand in the economy, the government would decrease the rate of taxation and increase the expenditures by making use of idle resources. This would lead to increase in the growth rate of the economy and would tend towards full employment by decreasing the rate of unemployment. As a result the output would increase. This kind of government spending has a multiplier effect because when a government starts a new project, along with the output of the project it generates employment for the workers and hence the consumption and savings. However Fiscal Policy might also be constrained by a crowding out effect which would happen if there is a rise in interest rates which would curb investment. However, if the economy is going through a recession then already a lot of resources are unused and hence this would not pose a problem f or the economy explicitly (Froyen, 2005). Monetary Policy The monetary policy is implemented by the Central Bank with a control on the money supply with is undertaken with the help of several methods. This can be controlled mainly by purchase or sell of bonds which increases or decreases the supply of the money in the economy. Now bonds are debt instruments that guarantee the buyer the return of the principal along with an interest or the coupon at some specified date. This rate of interest or the coupon rate is determined by the Central Bank and one of the tools by which the Central Bank controls the supply of money in the economy (Mankiw, 2012). Now, when the bank wants to reduce the money supply of the economy or decrease the liquidity, it would go for a Contractionary Monetary policy wherein it would start increasing the interest rates. As a result, the coupon rates of the bonds would increase which would compel people to park their money with the banks, having less money in the ir hands. This would lead to a reduction in liquidity in the entire economic system. In contrary to this by an Expansionary Monetary policy, the Federal Reserve Bank would decrease th