The federal government regulates the economy in various ways. Similarly, every country’s government takes steps in assisting the economy to achieve specific goals of full employment, price stability and growth. The United States’ government influences the country’s economic activity by use of two approaches, namely fiscal and monetary policy. By use of monetary policy, the government exercises its power in regulating the interest rates level and supply of money. Fiscal policy helps it use its power in taxing and spending.
Specifically, monetary policy is usually done by the Federal Reserve System, well known as the Fed. It has the power to take certain actions towards reducing or increasing the supply of money and increase or reduce interest rates in short-term. That makes it easier or harder to borrow funds. Upon believing that there is inflation problem, it uses contractionary policy in decreasing the supply of money as well as raising rates of interest. When there are higher rates, borrowers are forced to pay more for their borrowed money. Also, the banks become quite selective in giving loans. In the case of recession, expansionary policy is used by the Fed in increasing the supply of money and reducing rates of interest.
Concerning fiscal policy, the power of government to spend and tax is applied. Both government spending and taxation is used in increasing or reducing the total money supply in the economy. That implies the total amount that both consumers and businesses have to spend. During recession, the government increases spending, or reduces taxation. Both can also be applied at once. These actions put more money in the hands of consumers and businesses, this encouraging expansion of business and purchase of more goods and services by consumers. Upon application of contractionary measures for reducing business and consumer expenditure, prices go down, thus easing inflation.