- When a country such as the United States is experiencing serve and prolonged recessionary trend discount rate, term auction, and open market facility can provide useful means of ensuring that the economy returns in the right course. Discount rate is the interest rate that the central bank charges commercial banks and other depository institutions when they receive money from the Federal Reserve Bank's lending facility. During periods of prolonged recessionary trend, the Federal Reserve System should reduce the discount rate in order to encourage commercial banks and other financial institutions to lower the interest rate they charge to borrowers. Reducing discount rate for commercial banks will make them to reduce the interest rate charged on borrowers. This results into increase in money supply because individuals will easily afford loans at a fair interest rate. Consequently, the aggregate demand for commodities will increase simply because people will have enough money to purchase more (McEachern, 2011).
Open market operations involves buying and selling of government securities in the open market with the intention of expanding or contracting the amount of money in the banking system (Brezina, 2011). Buying of government securities from commercial banks by the Fed increases the amount of money held by the banking system and stimulates growth. When a country is experiencing serve and prolonged recessionary trend, the Fed should intervene and buy securities from the commercial banks and other depository institutions. This will increase the amount of money held by commercial banks to allow them give loans at lower interest rates. The supply of money increases in the economy thus reducing the interest rates charged by commercial banks. Additionally, the commercial bank reserves will also increase because the Fed will purchase assets and securities (McEachern, 2011).
- There are many reasons as to why conducting monetary policy is much easier than fiscal policy in a highly divided national political environment. To start with, fiscal policy represents visible changes in spending as well as taxation as opposed to monetary policy. Fiscal policy demands for cutting changing the level of spending and taxation. For example, a deflationary fiscal policy may require cutting the spending. However, no single organization will accept cutting down its spending aid in macro-economy recovery process. Spending cuts are politically unpopular for organizations. In most cases, taxes will prove unpopular regardless of the chosen tax.
Additionally, increasing corporation and income tax may have implications on the supply side. For example, increasing income tax may reduce incentives to work, or it could even encourage the rich to go and live abroad. Implementing expansionary fiscal policies also do not go without some difficulties. Even though reducing taxes may improve aggregate demand, government may find it difficult to reverse the tax regime when the economy starts to pick up. Budget deficits may also limit the success of a fiscal policy (McEachern, 2011). For example, a country may need expansionary fiscal policy during recession, but thus could lead to excessive borrowing which might prove unsustainable. This problem is particularly evident in the Euro-zone where excessive government borrowing can cause problems in other members of the Euro-zone.
A selected monetary policy committee implements the system of a monetary policy spending. It is through the efforts of the selected committee that the system works effectively compare to fiscal policy because the committee has influence on the unpopular political decisions that might have implication on the economy.
- Economists mean many things when they say that monetary policy can exhibit cyclical asymmetry. To some extent, monetary policy may be highly effective in controlling inflation and slowing expansion but this may not work well with an economy pushing recession. In other words, monetary policy can suffer from cyclical asymmetry. To some extent, when pursued vigorously, a tight monetary policy could deplete the reserves held by commercial banks to a point that they reduce the amount of loans they offer customers. This could result into contraction of the money supply into the market, high interest rates, and consequently the reduction of aggregate demand commercial banks as well as customers for those commercial banks. The Fed holds the responsibility of devising strategies to ensure that there are enough reserves for commercial banks regardless of the economic status (McEachern, 2011).
This possibility is significant to policy makers because an easy monetary policy alone may not help bring an economy out of recession. As the saying goes, “you can lead cow to water, but you cannot make it drink”. The Fed can increase reserves, but this does not guarantee that the banks will give loans and increase the supply of money. As such, commercial banks are seeking to liquidity and not ready to lend, the endeavors of the Fed would bear no fruit. Correspondingly, lenders can frustrate the efforts of the Fed by deciding not to borrow from the additional reserves. In addition, the public may use the excess money added into the economy through open market operation to pay off existing bank loans. Moreover, severe recession may reduce confidence of doing business thereby frustrating easy monetary policy.
McEachern, W. A. (2011). Economics: A contemporary introduction. Connecticut: Cengage Learning.
Brezina, C. (2011).Understanding the Federal Reserve and monetary policy. New York: The Rosen Publishing Group
Tankersley, J. (2013). Inside the Fed’s fight. Money, 42(1), 84-91. Retrieved from Business Source Complete, Ipswich.