Your Opinion: Government's role in fiscal policy
Wednesday, July 20, 2011
In my letter on basic economics published Tuesday, I explained that the federal government must use its power to stabilize the market in order to avoid the extremes of inflation or recession/depression as the market tries to stabilize itself. I noted that stability rests on the amount of money in circulation. Too much results in inflation and too little causes recession or worse. The government controls the money supply through the use of two tools: fiscal policy and monetary policy.
Fiscal policy rests on the Congress’ ability to raise and lower taxes. In times of recession there is too little money in circulation, unemployment is high and spending is low. To offset this the government can lower taxes so the people will be able to spend more. At the same time the people who have lost their jobs can receive unemployment checks so they can buy necessities until the economy improves.
In addition the government can funnel “stimulus money” into circulation to create jobs for the unemployed. Keep in mind that every dollar spent by someone becomes someone else’s income and as that dollar changes hands both spending and income increases and helps bring the economy out of recession. Currently we need more spending.
Monetary policy is controlled by the Federal Reserve and would require more explaining than space permits (assuming I know enough to explain it.) The Fed has the power to raise and lower interest rates and control how much money banks can loan. It may shock some of you to know that every time a bank makes a loan they create money and increase the money supply and when the loan is paid off that money disappears. Trust me, it’s true. (It is just a matter of addition and subtraction.) Our money is just numbers.
When the Fed needs money it issues IOUs called treasury bonds, notes, etc. For example, when I buy a U.S. savings bond, I am loaning money to the government. That bond is just an IOU and when the bond matures I get my money back plus interest. (So I own a part of the national debt.) When the Fed wants to increase the money supply they buy back their IOUs. When they want to decrease the money supply, they sell their IOUs taking money out of circulation.
These are a few of the basics. Go on line for more detail.
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