Economics Essay: Does Monetary And Fiscal Policy Work? At What Cost?

Huachu Yang
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Does Monetary and Fiscal Policy Work? At What Cost?
Introduction
Both monetary and fiscal policies have been employed extensively in several economies as nations endear for sustainable economic growth, a better environment for domestic and foreign investment, and stability in prices. Further, they enhance employment generation, maintain the balance of payment equilibrium, and raise economic welfare. There is the advocacy of these goals despite the prevailing macroeconomic challenges. However, the institutional framework that the government implements and the working environment determines the effectiveness of these policies. Attaining all of these objectives in tandem is quite difficult, meaning that policymakers bear the duty of identifying the priorities in the pursuit of economic policy (Idris 26). The impact of these policies is not only apparent in the aggregate economy but also in the micro-environment. However, they tag with their downsides, which are evident in growing deficits and possible inefficiencies in the products being delivered to the marketplace. Monetary and fiscal policies serve as important steps towards reviving and sustaining an economy, particularly during a recession, although they have major demerits when it comes to budget deficits and the government's contribution to inefficient products.
In successive economic crises, monetary and fiscal policies have played an important role.
Monetary and fiscal policies were frequently used in combination with both policies in the
economic crisis, financial crisis. By comparing the policy combination used by China and the
The United States, in response to the successive crises, there are significant differences between the two countries. Both China and the U.S. used a combination of both policies during 2008
the subprime crisis and the 2020 covid-19 pandemic, with the U.S. tending to focus on monetary
policy and China on fiscal policy.
The correct use of monetary and fiscal policy has been tested to be effective in all the crises in history, and can help us to better weather the crisis, and is good medicine for the macro-control
of the economic system. For example, during the 2008 financial crisis, the U.S. government passed
the Economic Stimulus Act of 2008 passed in February, which was an expansionary monetary
policy. The major part was to send cash totaling over $100 billion to individuals and families in
the United States(Taylor). China, on the other hand, launched its famous $4 trillion
infrastructure plan in 2008, which was an expansionary fiscal policy. In a contractionary gap, the
use of expansionary monetary/fiscal policy can speed up economic recovery.
At the same time, monetary and fiscal policies are not perfect; they do not solve the underlying problems, they only alleviate them, and there is a price to pay. For example, excessive deflation or inflation, and the long-term risks of excessive expansion of fiscal deficits. When policies are used incorrectly, they can lead to more rapid and more severe crises. For example, the subprime mortgage crisis of 2008. In late 2007, the Federal Reserve chose to raise interest rates when the stock market had just improved, completely igniting the subprime mortgage crisis and leading to an accelerated collapse of the financial system (Taylor) For China's $4 trillion infrastructure plan has created large local deficits, while a large amount of money has poured into the real estate market, causing the real estate bubble to continue to rise and high house prices to drive up the cost of living, with long-term consequences. The fiscal policy creates social value but allocative inefficiencies and market disruptions. Thus, both policies were effective but also had cost. And since we are currently unable to identify more effective alternatives, it is a serious question to consider how, how much, and when to use these policies before adopting them.
The United States focused on using monetary policy in the early as well as the later stages of the crisis. Under the impact of this year's covid-19 pandemic, the world once again experienced an economic crisis in which China and the United States of America continue to exhibit a starkly
different mix of policies to China. In March, the stock market plummeted, and unemployment and
corporate bankruptcies rose significantly. The Federal Reserve quickly implemented an
accommodative monetary policy in two weeks. For example, it quickly lowered interest
rates. At two unscheduled meetings, on March 3 and March 15 (Federal Reserve Press
Release), the Federal Open Market Committee (FOMC), the Fed's monetary policymaking body,
voted to reduce the target range for the federal funds rate by a total of 1.5 percentage points,
bringing it down to near zero. Significantly boosting money supply. Liquidity preference money supply and aggregate demand significantly while issuing dollars to provide direct stimulus to the
economy through open market operations, a quantitative expansion. So far, unemployment and
corporate bankruptcy rates have decreased, and the U.S. stock market has returned to its pre-crisis position. It can be argued that this use of monetary policy has been effective. Contrast this
with the monetary policy of 2008, which was also expansionary monetary policy such as
lowering the base rate and providing helicopter-money. However, the resources that the U.S. is putting into the market are monetary-based, not value-creating, improving the functioning of the real economy while causing the U.S. balance sheet to deteriorate.
The real economy, however, is not strong on the demand side of money due to the
poor functioning of the contagion. An excessive supply of money that does not keep pace with
the functioning of the real economy poses the risk of asset bubbles and an increase in the gap
between rich and poor. A quick rebound in the stock market does not mean that the problem is
solved. While people are more willing to hold cash against a backdrop of low interest rates, it is
more difficult for money to enter circulation. Keeping supply low but failing to improve the
demand side is the biggest problem with this policy, creating a liquidity trap. Shortly,
the U.S. GDP figures fell by a record 31.4 percent in the second quarter. Increase 33.1 in the
third quarter (trading economics). The question of how to recover the economy, will the present
recovery will continue in the future is a huge problem. So focus on monetary policy is a radical,
volatile strategy and much harder to control to find a 'balance cost'.
Figure1 (trading economics)
In the early stages of the epidemic, China adopted a tough quarantine policy, which led to a significant reduction in economic activity and had a significant impact on foreign trade,
particularly in the services sector. Supply chains were disrupted, and demand fell. China's
economy has likewise plummeted under covid-19, with both the supply and demand side of the
equation severely affected. China also used a similar monetary policy, such as open market
operations and moderately lower interest rates, which served the same purpose as the U.S.
monetary policy and proved to be effective. However, unlike the all-encompassing, aggressive
monetary policy of the United States, China's monetary policy is measured and controlled.
China's monetary policy is controlled and targeted. For example, China lowered its lending rate
from 4.05 percent to 3.85 percent, while the United States lowered it directly to near zero.
China favors fiscal policy, which encompasses both tax and government spending; on the tax side, it gives lower tax rates to specific companies, aggregate income rises, investment saving shifts to the right, and liquidity preference is a key element of the policy; which is money supply rising, aggregate demand rises. On the other hand, in terms of government spending, China
accelerated the implementation of a 5-year, 3.5 trillion-yuan scale of new infrastructure plans,
government spending rose, also raised aggregate demand as well as investment saving, this effect
is direct. As for the money supply, fiscal policy is not as direct and rapid as monetary policy to
increase the money supply, but in the long run, it can achieve the same purpose. At the same time, fiscal
policy drives many industrial chains and can be directed, greatly increasing short-term economic
activity, boosting GDP. It was effectively stimulating the demand side, and create social value, expand
the business cycle. However, the use of expansionary fiscal policy can also bring about huge costs; for example, higher inflation, increase deficits, and debt, makes a market run in inefficiency. In the financial crisis of 2008, the use of expansionary fiscal policy has led to a significant increase in the money supply.
When China similarly adopted a massive government spending fiscal policy to the tune
of RMB 4 trillion. The financial outlay eventually translates into revenue for the infrastructure
company, which has nowhere else to make an investment. Because there were not enough new
industries to absorb the money, a huge real estate bubble was created. Today's real estate bubble
in China is a huge risk due to the far-reaching effects of the fiscal policy implemented in 2008.
When systemic risk erupts, and the economic system fails to function properly, liquidity needs to
be injected to create social value. The advantage of monetary policy is that it is flexible, quick,
direct, and effective. It is therefore easy to see that both China and the U.S. used monetary policy
rapidly in the early days of the Covid-19 pandemic. But fiscal policy cannot be left, It initial
flexibility and direct effectiveness of the monetary policy.
Historically, During the 1930's great depression, the banking system collapsed, money lost liquidity, banks and businesses went bankrupt, the business cycle shrank, individual unemployment soared, and the system could not recover itself. The greater the crisis, the more appropriate to focus on fiscal policy because only use monetary policy even create a liquidity trap; with low-interest rates, people are more willing to hold cash, but it is more difficult to get money into circulation. And highly inflation, the dollar currency has plummeted, threatening the dollar system. Also, monetary policy is the inability to effectively stimulate the demand side, and we must use a combination of those two policies. Monetary policy and fiscal policy are worked efficiently when we use them together. They are important tools to deal with the crisis.
Monetary policy tends to be supply-side, and providing sufficient liquidity at the beginning of a crisis can be effective in the short term to mitigate systemic risk in the market. However, too much focus on the supply side can lead to inflation and liquidity crisis, create long-run risk. That is the real cost. Also, focus too much on fiscal policy is leading to a huge cost. Today's China and the United States give us an answer about how to combine those two policies. Show how the policies worked and what the real cost they are created. Therefore, a combination of fiscal policy, also focusing on the demand side, is needed to find the optimal balance.
Monetary Policy
The monetary policy has been an existent procedure dating back to the 17th century when the Bank of England was tasked with printing notes and backing them with gold. The primary objective of the monetary policy was sustaining the value of the currency and, onwards, the printing of notes. According to Warin (3), "Monetary policy is the process of overseeing a nation's money supply to complete specific objectives such as restraining inflation, or achieving full employment." The inception of the policy in England resulted in its adoption among many developed nations. To this end, monetary policy is articulated through several channels, often referred to as the instruments of monetary policy.
Chief among these instruments is the interest rate. In essence, this instrument determines the cost of borrowing funds a...