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If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked. This is a preview. Log in to get access Journal Information Current issues are now on the Chicago Journals website. Read the latest issue.One of the oldest and most prestigious journals in economics, the Journal of Political Economy (JPE) presents significant and essential scholarship in economic theory and practice. The journal publishes highly selective and widely cited analytical, interpretive, and empirical studies in a number of areas, including monetary theory, fiscal policy, labor economics, development, microeconomic and macroeconomic theory, international trade and finance, industrial organization, and social economics. Publisher Information Since its origins in 1890 as one of the three main divisions of the University of Chicago, The University of Chicago Press has embraced as its mission the obligation to disseminate scholarship of the highest standard and to publish serious works that promote education, foster public understanding, and enrich cultural life. Today, the Journals Division publishes more than 70 journals and hardcover serials, in a wide range of academic disciplines, including the social sciences, the humanities, education, the biological and medical sciences, and the physical sciences. Rights & Usage This item is part of a JSTOR Collection. When it comes to influencing macroeconomic outcomes, governments have typically relied on one of two primary courses of action: monetary policy or fiscal policy. Monetary policy involves the management of the money supply and interest rates by central banks. To stimulate a faltering economy, the central bank will cut interest rates, making it less expensive to borrow while increasing the money supply. If the economy is growing too rapidly, the central bank can implement a tight monetary policy by raising interest rates and removing money from circulation. Fiscal policy, on the other hand, determines the way in which the central government earns money through taxation and how it spends money. To stimulate the economy, a government will cut tax rates while increasing its own spending; while to cool down an overheating economy, it will raise taxes and cut back on spending. There is much debate as to whether monetary policy or fiscal policy is the better economic tool, and each policy has pros and cons to consider. Key Takeaways
An Overview of Monetary PolicyMonetary policy refers to the actions taken by a country's central bank to achieve its macroeconomic policy objectives. Some central banks are tasked with targeting a particular level of inflation. In the United States, the Federal Reserve Bank (the Fed) has been established with a mandate to achieve maximum employment and price stability. This is sometimes referred to as the Fed's "dual mandate." Most countries separate the monetary authority from any outside political influence that could undermine its mandate or cloud its objectivity. As a result, many central banks, including the Federal Reserve, are operated as independent agencies. When a country's economy is growing at such a fast pace that inflation increases to worrisome levels, the central bank will enact restrictive monetary policy to tighten the money supply, effectively reducing the amount of money in circulation and lowering the rate at which new money enters the system. Raising the prevailing risk-free interest rate will make money more expensive and increase borrowing costs, reducing the demand for cash and loans. During and after the Great Recession, the Federal Reserve made use of quantitative easing as a means to spur the economy. The Fed can also increase the level of reserves commercial and retail banks must keep on hand, limiting their ability to generate new loans. Selling government bonds from its balance sheet to the public in the open market also reduces the money in circulation. Economists of the Monetarist school adhere to the virtues of monetary policy. When a nation's economy slides into a recession, these same policy tools can be operated in reverse, constituting a loose or expansionary monetary policy. In this case, interest rates are lowered, reserve limits loosened, and bonds are purchased in exchange for newly created money. If these traditional measures fall short, central banks can undertake unconventional monetary policies such as quantitative easing (QE). Monetary Policy Pros and ConsPros
Cons
An Overview of Fiscal PolicyFiscal policy refers to the tax and spending policies of a nation's government. A tight, or restrictive fiscal policy includes raising taxes and cutting back on federal spending. A loose or expansionary fiscal policy is just the opposite and is used to encourage economic growth. Many fiscal policy tools are based on Keynesian economics and hope to boost aggregate demand. Fiscal Policy Pros and ConsPros
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What Is the Difference Between Fiscal Policy and Monetary Policy?Fiscal policy is policy enacted by the legislative branch of government. It deals with tax policy and government spending. Monetary policy is enacted by a government's central bank. It deals with changes in the money supply of a nation by adjusting interest rates, reserve requirements, and open market operations. Both policies are used to ensure that the economy runs smoothly; the policies seek to avoid recessions and depressions as well as to prevent the economy from overheating. What Are the Main Tools of Monetary Policy?The main tools of monetary policy are changes in interest rates; changes in reserve requirements (how much reserves banks need to keep), and open market operations, which is the buying and selling of U.S. Treasuries and other securities. What Are Examples of Fiscal Policy?Fiscal policy involves two main tools: taxes and government spending. To spur the economy and prevent a recession, a government will reduce taxes in order to increase consumer spending. The fewer taxes paid, the more disposable income citizens have, and that income can be used to spend on the economy. A government will also increase its own spending, such as on public infrastructure, to prevent a recession. The Bottom LineMonetary and fiscal policy tools are used in concert to help keep economic growth stable with low inflation, low unemployment, and stable prices. Unfortunately, there is no silver bullet or generic strategy that can be implemented as both sets of policy tools carry with them their own pros and cons. Used effectively, however, the net benefit is positive to society, especially in stimulating demand following a crisis. Which of the following statements comparing the lags of monetary and fiscal policy is accurate?Which of the following statements comparing the lags of monetary and fiscal policy is accurate? The policy-making lag for fiscal policy is longer than monetary policy.
How does fiscal policy's response lag compare with that of monetary policy?The monetary policy has a shorter time lag than the fiscal policy. This is because the central bank that implements monetary policies is not a government bureaucracy, this, in turn, makes the tools it uses more effective and efficient than fiscal policy tools.
Does the monetary and fiscal policy have lags?Policy makers at the Fed still have to contend with the impact lag, the delay between the time a policy is enacted and the time that policy has its impact on the economy. The impact lag for monetary policy occurs for several reasons. First, it takes some time for the deposit multiplier process to work itself out.
What are the typical lag times of monetary and fiscal policies?Time lags can make policy decisions more difficult. It is estimated interest rate changes take up to 18 months to have the full effect. This means monetary policy needs to try and predict the state of the economy for up to 18 months ahead, but this can be difficult in practise.
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