Fiscal Neutrality

And finance Allah shmoop What is the difference between fiscal

policy and monetary policy Okay well you find yourself at

a party with a bunch of economists first Sorry Yeah

You need a wider array of friends clearly here And

second if you have to be there anyway why not

throw some gasoline on the conversational fire Now at least

poke the social corpse Well here's what you d'Oh ask

whether they're monitoring CE or Keane's Ian's Yeah we know

that doesn't sound like much but believe us with economists

all would turn this into this or maybe even into

this which will really stir the pot All right well

why Because monitoring us and Kenyans focus on different aspects

of government to impact the economy you could say they

uh you know believe in different magic monitor its focus

on monetary policy Surprise surprise and Keane's Ian's focus on

fiscal policy Okay monitoring they're all about the money Like

you know Jerry Maguire's guy Show me the money They

believe that by changing the money supply the government can

impact the economy Well how does the government supply money

Well the short answer is that the government prints the

money Yeah that cash in your pocket it comes from

somewhere but the actual process is more complicated The main

actor here in the U S Is the Federal Reserve

which is the U S central bank Every currency will

have a central bank That's the thing that controls the

money supply And you could say that the Fed controls

the flow of dollars Well how does it do this

magic key thing Well to fight recession the Fed can

lower interest rates Cutting rates makes cheap money so that

well people can borrow easily And then they get more

stuff for more of it to spend on stuff you

know to buy stuff which makes the economy go running

around well The Fed can also lower reserve requirements for

banks so that banks don't have to keep his much

collateral or cash in stock And then they can loan

out more money basically making more money available in the

the system More liquidity in the system cheaper easier available

money for people to borrow and or the Fed can

buy securities like swapping cash for equities or debt All

right so it's supplying the economy Then with cash Ola

and the Fed does stuff like this all the time

They're adding cash to the system and then drawing it

out later The more dollars out there while the more

there is to spend think about it like grocery store's

having a whole bunch of cassava melons on a warm

day They've got to get those melons out to the

public and get him eaten or well they end up

looking like this Yeah well the buzzword for your wild

and crazy party times is expansionary As an expansionary monetary

policy that is this set of activities is aimed at

expanding the growth prospects of the economy by making it

easier for buyers to buy You know like J T

sings at Bye baby Bye baby Bye baby So that's

on the stimulus side Growing a week or anemic economy

But what about when the central bank wants to fight

inflation because things have gotten too hot Well the value

of a dollar then is plummeting and old people who

have to hold secure safe low interest rate bonds are

losing buying power and they have to live in their

station wagons than down by the river What happens then

Well to fight inflation The central bank then tries to

contract the money supply puts it right on Weight Watchers

Basically it does the opposite of all of the previous

things It raises interest rates and raises bank collateral or

reserve minimums And it sells securities like it sells its

own T bills cash out of the system and putting

in its place well a bunch of paper promises to

pay it all back someday Well the goal here is

to take money out of the system right Higher interest

rates and higher bank reserves make it harder and or

more expensive for Joe Consumer and Joe Corporation to borrow

money moves then more slowly through the economy Less cash

is in the system so it means less of it

to go around Yeah inflation then is knocked out or

at least friction ized or made slower Okay that's monetary

policy using the money supply to control the economy On

the other side of the coin are that Kenyans who

have a long history of being excellent runners the high

altitudes develop amazing lungs Wait wait That's something different Editor

he given the wrong paragraph Okay well that Keen's Ian's

Air Actually economists named after John Maynard Keen's and well

their economic magic is all about well managing the government

like new spending that well the government will take on

and then used to optimize whatever its vision of the

perfect economy is Okay So what does all this mean

While the process is generally called fiscal policy right Well

the main player this time is not the Federal Reserve

It's Congress and the president right It's the government getting

directly involved in managing the economy well Politicians hoping to

improve economic conditions have two main tools at their disposal

Fortunately for them and for the rest of us the

basic principle behind them are pretty simple The core thinking

is that inflation and recession are opposites of one another

During periods of recession there isn't enough money circulating in

the economy It's constipated During periods of inflation there's too

much money It's just gotten home from Indonesian food So

the answers to these problems and well so either put

money in or take money out of the economy As

a result when the economy is tanking the government can

increase its own spending or lower taxes When times are

bad people are out of work and businesses don't have

customers So Keens said the government should come in and

make up the difference Big Momma Government Yeah buy stuff

employed People put people on the dole dig holes filling

back up Where does the money come from Taxes Eventually

deficit spending Borrowing now on the other side of things

to fight inflation Well then the government does the reverse

The economy's going crazy Inflation is building bubbles or forming

tokens Ian Think the government should play a party pooper

here Raised taxes suck money out of the economy Meanwhile

the government curves its own spending so it doesn't add

to the wild party time right till the problem Government's

rarely do of this part People hate party pooper they

don't vote for them And members of Congress and the

president are elected by yes the people When times are

good politicians just want them to be better Maur Deficit

Spending More Borrowing Well the people the Federal Reserve have

the advantage of not being elected and the average Joe

six pack and not really knowing what they do well

it gives the Fed a lot more freedom to be

party poopers Alright recap time Fiscal policy involves government spending

in taxes while monetary policy involves the money supply in

the U S Congress and the president run fiscal policy

While the Federal Reserve runs monetary policy to stimulate the

economy the Fed can lower interest rates lower bank reserve

requirements or by security's on the open market which creates

more cash out there in the fields It's attempt down

the economy The Fed would reverse these like raise rates

increase bank reserve requirements and sell securities On the physical

side the government can pump up the economy by lowering

taxes and increasing spending to slow things down It can

raise taxes and lower its own spending right So yeah

that's fiscal v monetary policy Thus smackdown Of course Well

there's also honesty which if you ask most kindly grandmothers

is the best policy But it didn't work in politics