Expansionary Fiscal and Monetary Policies: Actions Undertaken by the Federal Reserve

This paper explains the expansionary fiscal and monetary policies undertaken by the Federal Reserve and the government. It discusses the necessary changes in taxes and government spending, impact on aggregate demand, GDP, and employment. It also explains the actions of the Fed in regard to the three tools of expansionary monetary policy.

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Introduction
The current elucidates illustratively about the actions undertaken by the Federal Reserve to
move out of recession. The study at hand also explains in detail about the actions that the
government undertakes for addressing expansionary fiscal as well as monetary policies. The
current section explicates illustratively regarding expansionary fiscal policies from the
perspective of the essential alteration in taxes as well as government spending, impact on
aggregate demand, employment as well as GDP. Moving further, the present study also
illustrates in detail about the expansionary monetary policy and the tools that the Federal
Reserve utilizes at the time of undertaking monetary policy.
Expansionary Fiscal Policy
- Necessary changes in taxes and government spending
The fiscal policy is in effect the way by which a particular government adjusts levels of
spending and rates of taxation for monitoring and influencing economy of a nation. Basically,
it can be regarded to be a sister strategy to monetary policy by which a central bank exerts
influence on supply of money of a nation (Nakamura & Steinsson, 2014). Therefore, it can be
hereby said that fiscal policy elucidates two different governmental activities by the
government that includes taxation and government spending. By means of levying tax,
governing bodies accept and at the same time serve diverse specific purposes, however, the
important notion is that taxation is a way of transferring assets from mainly the people to the
government. Particularly, the second action is primarily government spending. This might
perhaps be in the form of wages to government employees, social security advantages, and
superior road facility otherwise fancy weapons. At the time when the government expends,
they reassign assets from itself to general public (even though in case of weaponry, it is not
always obvious that the population holds the assets) (Melosi, 2016). As taxation along with

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government spending reflects reversed flows of asset, these policies can be considered to be
opposite strategies.
Essentially, lessening taxes and increasing government spending can be regarded to be
expansionary fiscal policies. At the time when the government lowers taxes, consumers have
higher disposable earning. At the time when the government decreases level of taxes,
different consumers have considerably higher disposable income. In terms of economy on the
whole, this can be replicated in the output equation presented below:
Y= C(Y-T)+I+G+NX
Here, Y reflects gross domestic product, C represents consumption that includes both durable
as well as non-durable products as well as services. I reflect Investment that is comprised of
value possessed by businesses as raw materials and work in progress, inventory of different
unsold finished goods, different plant along with equipment and many others (Tabellini,
2016).
In this case, a reduction in T, provided a stable Y directs the way towards an enhancement in
C and finally to an increase in Y.
Increasing spending of the government is said to have similar effects. At the time when
government expends more amount of money on both goods as well as services, accepts more
amount of money (Hagedorn et al., 2017). When considered in terms of the economy on the
whole, this again can be reflected by the equation represented below:
Y=C(Y-T)+I+G+NX
In this case, an enhancement in G leads to enhancement in Y. Therefore, expansionary fiscal
policies help in making the populace wealthier and augment output, otherwise national
earning.

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- Effect on aggregate demand, GDP and employment
Fiscal policy exerts impact on aggregate demand through alterations in government spending
as well as taxation. Essentially, government spending along with taxation exert impact on
employment along with household income that in turn dictates spending level of consumers
and investment. Expansionary fiscal policies normally implemented in response to recessions
or else employment shocks, enhances government expenditure in definite areas namely
infrastructure, education as well as unemployment benefits (Tenreyro & Thwaites, 2016). As
per Keynesian economics, these specific programs prevent a negative transformation in
aggregate demand by means of stabilizing employment among different government
employees and individuals engaged with stimulated sectors. Essentially, extended benefits of
unemployment help in process of stabilization of consumption and investment of different
jobless individuals during recessionary period.
Figure 1: Expansionary Policy on GDP/aggregate demand
(Source: Baker et al., 2016)
Normally, fiscal policy is said to exert impact on GDP by means of influencing aggregate
demand. At the time when the government alters the fiscal policy, it alters the amount of

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money possessed by individuals. For instance, in case if it lessens the taxes and enhances
spending of government, it creates individuals to have more amount of money. At the time
when individuals have more amount of money, they have the tendency to demand higher
amounts of goods as well as services (Cúrdia & Woodford, 2016). Thus, this raises the total
amount of GDP of a nation.
Figure 2: Effect of Monetary and Fiscal Policy on GDP
(Source: Cúrdia & Woodford, 2016)
Fiscal Policy of the United States
The government of the USA has encountered momentous task of reversing impacts of
recession with an assimilation of expansionary as well as monetary policy. Particularly, on
the fiscal side, government stimulus expenditure as well as tax cuts prevented further
deterioration of the economy. However, on the monetary viewpoint, the Federal Reserve has
managed weaknesses of economies with both traditional as well as unconventional strategies.

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The government of USA have inclination to spend higher amount than what it takes in and
therefore has necessarily incurred fiscal deficits uninterruptedly during the last decades
(Bianchi & Ilut, 2017). At the time when the governing bodies handled to balance a budget in
recent history that is between the period 1998 and 2001, that is when the strong economy led
to higher than normal revenues from taxation. Essentially, fiscal deficit of the nation reached
the greatest point since the period 1945 in the year 2009 to 9.8% of gross domestic product.
However, it has improved gradually since that period and the deficit declined to
approximately 2.4% of gross domestic product during 2015 (Rezai & Stagl, 2016). The
greatest fraction of the government spending is primarily mandated by the subsisting
regulations, with a huge amount of finances allocated to entitlement programs namely the
Social security as well as Medicaid. Obligatory expenditure reflects approximately 60% of
overall government spending. Again, the remainder can be indicated as discretionary expend,
and is ascertained by the yearly federal budget (Moreira & Savov, 2017). Approximately, half
of discretionary budget is expended on military as well as defence with other half expended
on government spending as well as public services.
Approximately 50% of tax acquired by the government of USA comes from income taxes on
particularly individuals with supplementary 10% acquired from income taxes on different
businesses as well as institutional units. 35% is derived from payroll as well as social security
taxes. Again, excise taxes levied on goods namely tobacco, liquor as well as gasoline
introduce smaller amount, that is lower than 5%. In itself, tax revenues equalises to around
18% of GDP on an average between the period 1970 and 2010. In addition to this, the total
tax revenues as a percentage of GDP were around 18% in GDP (Goodwin et al., 2015). In
essence, the stimulus package introduced by Obama administration counted USD 288 billion
in tax cuts as well as incentives. However, two years after, the Obama declared an overall

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extension to the reduction of tax that had been established during administration of Bush at a
cost of over and above US$400 billion over two years.
Expansionary Monetary Policy
Actions of the Fed in regard to the three tools
-When the required reserve ratio is increased or decreased
When the reserve ratio is decreased through expansionary policy, then commercial banks
have the need to hold less amounts of cash at hand and can enhance total amount of loans
offered to consumers and businesses. This enhances overall supply of money and leads to
economic expansion, growth of economy and inflation rate. On the other hand, when the
reserve ratio is increased through contractionary policy, this reduces the rate of inflation but
simultaneously decreases growth (Bernanke et al., 2015).
-When the discount rate is increased or decreased
When the Fed decreases the rate of discount, excess reserves in different commercial banks
increases in particularly commercial banks throughout the entire economy and expands
overall supply of money (Borio, 2014). Again, in contrast, at the time when Federal Reserve
increases the rate of discount, this lessens excessive reserves in particularly commercial
banks and at the same time contracts supply of money.
In essence, the Federal Reserve can necessarily affect supply of money by means of utilizing
rate of discount as it can affect the total lending amount that goes in a specific economy.
Fundamentally, rate of discount is essentially the interest rate that necessarily the Fed charges
from banks that intend to have a loan from it. Essentially, interest rate that in itself Fed
charges exerts impact on rates of interest that banks charge on themselves (Heijdra, 2017). As

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such, the rate of interest that banks charge is necessarily the price that both individuals as
well as firms need to pay for borrowing from banks.
Fundamentally, economic regulations mention that when price decreases of a particular thing,
then individuals tend to purchase more of that particular thing. Borio (2014) suggests that
when borrowing price decreases, individuals start to borrow more. However, when
individuals borrow more money, money supply inevitably increases. In essence, it is due to
the fact that every time individuals borrow money, individuals make more of the same. For
instance, in case if $1000 is deposited in a bank and $1000 is borrowed, supply of money
increases by $1000. In actual fact, the original $1000 still remains in the bank and whosoever
the money belonged to receive the same. At the same, person who has borrowed the money
possess $1000 that necessarily did not exist in the past. Basically, this implies that the bank
and the borrower generated $1000 as new money at the time money was borrowed.
Therefore, in case if the Fed lessens the rate of interest, then it enhances the money supply. In
essence, if it enhances the rate of discount, the same raises the borrowing price and supply of
money declines (Agénor & Montiel, 2015). Adjustment of rate of discount can be considered
to be an important tool by means of which Federal Reserve can control supply of money. Fed
itself describes rate of discount as rate of interest that is charged to different commercial
banks as well as other depository institutions on amounts of loan received from regional
lending facility of Federal Reserve. Therefore, this incentivizes banks to maintain high cash
reserves that they can in turn do by raising rates of interest, particularly both on loans to
different consumers and on savings account. Therefore, by increasing or else lowering rate of
discount, the Fed can essentially compel banks to maintain more money in reserve.
Essentially, this lowers overall amount of money that is in circulation- the supply of money.
Also, it can also work in an opposite way by decreasing the rate of discount (Mankiw, 2014).

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Further, there are also different tools that the Fed can utilize to put into practice monetary
policy, but the rate of discount can be considered to be the most important one.
-Buying or selling government securities when conducting expansionary monetary
policy
Developing monetary policy of a nation is considered to be an extremely important factor at
the time of promotion of economic growth that is sustainable in nature. More specifically,
monetary policy concentrates on the way a nation ascertains the size and growth of its money
supply in a bid to control inflation within the nation. Particularly, in the United States, a
specific committee operating within the Federal Reserve is accountable for executing
monetary policy. Particularly, The Federal Open Market FOMC both purchases and sells
government securities to establish the supply of money (Agénor & Montiel, 2015).
Particularly, this procedure is known as open market operations. Essentially, the government
securities that are utilized in open market operations are necessarily treasury bills, notes and
government bonds. In case if the FOMC intends to enhance the supply of money in the
economy it will purchase securities. Contrarily, in case if the FOMC intends to decrease the
supply of money, then it will sell securities.
In order to enhance the supply of money in the market, the FOMC will buy securities from
different banks. The funds that different banks acquire from the sale can be utilized as loans
to different individuals as well as businesses. In particular, the more the amount of money
available in the market for the purpose of lending, the lower the rate on these loans become
that subsequently causes higher number of borrowers to access cheaper capital (Bernanke et
al., 2015). Essentially, this easy access to capital directs towards greater amount of
investment and this can regularly fuel overall economy.

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However, in order to lessen over supply of money, the FOMC shall securities to banks that
directs towards money being taken out of banks and maintained in reserves of FOMC. The
reduction in availability of money in the economy directs towards decline in investment as
well as spending since the availability of capital reduces and the same becomes even more
expensive to obtain.
During the period of recession, the Federal Reserve has been very dynamic. Rates of interest
were primarily supposed to be maintained at a low level until rate of unemployment
decreased to 6.5% otherwise inflation exceeded 2.5% (Moreira & Savov, 2017).
Nevertheless, this particular forward guidance was refurbished during March 2014 at the time
when the Fed declared that any decisions regarding increasing rates of interest in the future
period no longer relied on previously-instituted quantitative factors, but rather on the
assessment of a broad range of more qualitative information. In an additional response to
counter the impacts of recession, during the period of December 2012, the Federal Reserve
declared an unconventional strategy referred to as quantitative easing. In essence, this
strategy includes purchase of huge sums of financial assets for increasing supply of money
and hold down rates of interest.
Way the actions would affect money supply, rates of interest, spending, aggregate
demand, GDP and employment
Expansionary monetary policy is said to enhance money supply in a specific economy. In
essence, augmentation in money supply necessarily gets mirrored by an equivalent
enhancement in nominal output, or in other words, Gross Domestic Product. Furthermore, the
enhancement in supply of money can direct the way towards augmentation in consumer
spending. In essence, this increase shifts the aggregate demand curve towards the right
(Bianchi & Ilut, 2017). Additionally, enhancement in supply of money can direct the way

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towards upward movement along the supply curve. Essentially, this can direct the way
towards increase in price and higher output (real in nature). Also, an expansionary monetary
policy can be used to augment growth of the economy, and normally decreases rate of
unemployment and enhances rate of inflation (Hagedorn et al., 2017).
Diagrammatic representation
As part of expansionary monetary policy and in order to deal with decreasing rate of growth
of economy, the FED reduced the rates of interest. Even though the Fed decreased rate of
interest by 0.25%, this was considered to be a part of the expansionary monetary policy.
Figure 3: Effect of expansionary monetary policy on rate of interest
(Source: Hagedorn et al., 2017)
In this case, money supply can be shown as a vertical line at a specific stage controlled by the
stage. In this case, the Fed enhances supply of money by utilizing market operations
(Hagedorn et al., 2017). The enhancement in the supply of money is reflected by a rightward
shift in the supply of money from MS 1 to MS 2. The enhancement in money supply
decreases interest rates of the market from r 1 to r 2.

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However, at the time when rates of interest decreased, investment increases from the level of
I1 to I2.
Figure 4: Effect of expansionary policy on investment
(Source: Hagedorn et al., 2017)
The decline in the rates of interest directs towards investment demand to increase. As
investment is a specific element of GDP, therefore of aggregate demand, an increase in
overall investment directs towards to higher aggregate demand as well as output (Hagedorn et
al., 2017). In itself, the results are an enhancement in output, a decrease in the rates of
unemployment.
Conclusion
The above study helps in gaining deep understanding regarding actions undertaken by the
United States to counter the effects of recessionary pressures. The actions for undertaking
expansionary fiscal policy and monetary policy are elucidated in detail in the current study
under consideration.

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