what are the major tools of monetary and fiscal policy on controlling iflation?
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Fiscal policy to control inflation makes use of tax increases and spending cuts. These things reduce aggregate demand because there is less money out there "chasing" products. Therefore price levels drop.
Monetary policy involves shrinking the money supply -- increased interest rates, selling of government bonds, increased requirements for how much banks have to keep in reserves.
Monetary policy in the United Stated is controlled by the Federal Reserve. As mentioned above they can control the amount of money in circulation by controlling interest rates. Fiscal Policy is a function of the government in that it can increase taxes or provide tax cuts.
A government's chief methods of preventing a depression are by its fiscal policy and its monetary policy. Fiscal policy refers to the actions taken by a government in the area of taxing and spending programmes, monetary policy refers to the way a government manages the the total quantity of money in the country, including cash and bank deposits. Government can use a combination of both these policies to control inflation and recession.
Inflation occurs in an economy as the result of a rise in effective demand, or the total spending by consumers, business, and government.
The government can control inflation by reducing its own spending, and also by reducing the spendable income of consumers by raising taxes. When consumers spend less money, the demand for goods and services decreases causing prices to fall. Thus a government can prevent inflation by encouraging spending. Tax increase, for example, give people less money to spend.
To combat inflation through government can adopt a tight monetary policy, taking action to decrease the money supply. It is possible to decrease the money supply by raising reserve requirement of banks, which limits the amount of money banks can lend. It is also possible to decrease the money supply by selling government bonds.
Monetary policy is set by the Board of Governors of the Federal Reserve Bank, which is a quasi-public bank. Monetary policy depends on the M1, M2, and M3 supply of money measurements, which measure checkable-deposits and two categories of savings deposits.
Monetary policy regulates money supply through the creation of money through lending and the regulation of interest rates. The Fed's monetary policy instruments are open market operations, the reserve ratio, and the discount window rate. Monetary policy changes commercial bank reserves, which affects the M money supply through changes in lending, which affects interest rates that the Fed can also alter, which affects business investment.
Fiscal policy pertaining to public treasury or revenue is regulated through the instruments of changes in government spending and changes in taxation. Policy calls for increase in spending and decrease in taxes to create a deficit in order to correct for recession. Correction for demand-pull inflation calls for decrease in spending and increase in taxes to create a surplus.
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