Term Papers on FISCAL AND MONETARY POLICY

Term Paper Title	FISCAL AND MONETARY POLICY
# of Words	1048
# of Pages (250 words per page double spaced)	4.19

FISCAL AND MONETARY POLICY

Monetary Policy
· Refers to the action undertaken by the RBA to affect the price and quantity of money and credit in the economy.
· In Australia, it works through interest rates, which affects the level if private investment and consumption expenditure.
· The RBA uses open market operation – the buying and selling of government securities to set short-term interest rates.
· To contract the economy the RBA raises the cash rate, which then flows onto other interest rates. The cost of borrowing funds for investment increases and this helps to reduce spending in the economy. Monetary policy in this case is said to have “tightened”.

Fiscal Policy
· Refers to the use of govt revenue and expenditure to influence the level of economic activity – the level of income, output and employment.
· Fiscal policy is implemented through Commonwealth Budget, which now occurs in May each year and is sometime referred to as budgetary policy.
· Fiscal policy involves adjusting govt expenditure in areas such as defence, social security, health and education, and altering tax rates such as personal income, company, sales and excise duty.
· If the govt wanted to contract economic activity, it would plan for either a reduced budget deficit or an increased budget surplus. This means that in the circular flow model, G is reduced relative to T, which should help to reduce aggregate demand in the economy and thereby reduce national income and output.

Monetary policy together with fiscal policy are the two primary policies the govt uses to control the macroeconomy by affecting the components of aggregate demand.

The economic circumstances in which monetary policy might be preferred
· Monetary policy is a more flexible instrument than fiscal policy and for this reason it may be preferred to be used when the govt wishes to “fine-tune” the economy.
· It has in fact played the role of “swingman” in Australia’s recent past.
· It has the advantage of a very short implementation lag as opposed to fiscal policy.
· The RBA constantly monitors a wide range of economic indicators and then adjust short-term interest rates with a view to conditions sometime into the future.
· The RBA does not require the formal consent of the govt of parliament when its sets its policy strategy.

· It is a much better instrument for achieving the objective of price stability.
· Most central banks around the world believe that the prevention of inflation should be the primary objective of the monetary authority.
· Inflation is believed to be primarily caused by excessive growth in the money supply.
· Monetary policy by controlling the financial sector and liquidity in the economy, is therefore seen as being best suited to the goal of price stability.

· Works best in boom conditions in contracting the economy rather than in times of recession.
· When the economy is growing at a fast pace, credit restrictions and/or increases in interest rates are an effective method to help curb spending.
· In times of recession however, monetary policy is not very effective in stimulating spending. The phase “pushing in a piece of string” is often used to illustrate the ineffectiveness of monetary policy when the economy is recessed.

· Often seen to be more politically palatable than fiscal policy and there may be times when the govt would prefer to...

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