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Fiscal and monetary policy are two very important tools used to regulate, stimulate, or control the GNP and/or economic growth.

The preceding chapters on money and banking and taxation have provided an excellent introduction to this study.

Fiscal policy is the system related to taxation. Monetary policy relates to money and banking.

The U. S. government obtains money from taxes. As you learn and study about the different kinds of taxes, you will begin to realize this is a very large amount of money.

The government has the right and the responsibility to levy taxes. Congress also provides the government with the ways and means for collecting the taxes.

Let's take a brief look at various kinds of taxes and how they are collected.

Federal and state income taxes must be filed by individuals and businesses annually.

The amount of the tax is based on the amount of income that was received by the individual or business.

A consumption tax is paid by the consumer when a product is purchased. This is a percentage that is added to the cost of the item purchased.

Taxes on alcohol, tobacco, and gasoline are consumption taxes.

"Pleasure" taxes are collected for benefits (or pleasure) received.

Tolls paid on roads, highways, and bridges are examples of pleasure taxes.

Taxes paid on imports and some exports are called tariffs.

A tariff is designed to limit or restrict foreign trade.

The government uses taxes to regulate the economy.

When the economy is in a recession or a downward swing, taxes may be lowered so that individuals may have more spendable income.

Decreasing personal income tax becomes a popular campaign issue during the time of national elections.

Fiscal policy is regulated and enforced by the federal government.

It is used to stimulate saving and investing and to control consumption, limit or encourage trade, and to decrease or increase consumers' spending.

When there is a need to control the use of gasoline, the gas tax is increased.

To stimulate the use of gasoline, the tax is lowered.

When the tax is raised on economic goods, consumers will purchase less or seek a suitable alternative.

When the government is pressured to do something about the health risk of smoking, for instance, the tax on tobacco will be raised.

When schools in a particular area need to build or provide better facilities, they will go to the homeowners and ask them to pass an ad valorem tax.

Monetary policy is used to maneuver economic spending.

If the country is in a recession or nearing depression, the government will lower interest rates to stimulate borrowing.

All of a sudden, the dollar is worth more and consumers are more likely to spend.

Part of "the American dream" is for a person to have enough money to do whatever he or she wants to do.

In order for this to happen, many things must fall into place.

One of the most important items that will affect the "dream" is what a person chooses to do with his or her disposable income.

Disposable income is whatever is left to spend after all other deductions have been made.

This means money that is left after taxes are paid, the cost of running a household is deducted, and all other monetary obligations are met.

Also, when interest rates are lowered, the rewards for saving are less.

People tend to look for alternative investment methods that will yield higher interest or to stop systematically saving and investing until interest rates increase.

During periods when the interest rate fluctuates greatly, financial advisors usually encourage clients to keep a portion of their assets liquid so that they may be moved quickly to take advantage of various opportunities in the market.

Liquid assets are money, personally owned items of value, or other investments that can be converted to cash immediately.

During periods of high interest, investors are more likely to keep their assets in non-liquid form.

Non-liquid assets are investments made for longer terms and are not easily converted to cash.

Many long-term investments have stiff regulations that govern the amount of time funds must be invested and the penalty for early withdrawal of funds from the investment.

The financial institution is required to inform the purchaser of these regulations at the time of purchase.

Investors are encouraged to spread their investments into several investment tools.

By doing this, investors can more easily withstand fluctuations in the yield on their investments.

If one stock or bond decreases, another may increase to offset any loss.

One of the most stable and safe investments is U.S. Savings Bonds.

These typically pay a very low interest rate, but they are very secure.

This is because during a catastrophe, the last entity to be affected would be the government.

Its money would remain in place far longer than that of business or industry.

Controlling the supply of money.

As we have studied in previous lessons, the American economy is subject to fluctuations that are accompanied by changes in the price level.

There is a relation among the supply of money (M), the price level (P), and business activity (T).

Controlling the supply of money.

Through its control over discount rates, open market operations, and the reserve ratio, the Federal Reserve helps in the effort to provide a full-employment noninflationary economy.

DISCOUNT RATE

We know that the Federal Reserve banks provide a banking system for private commercial banks.

Banks use this system in two main ways - for depositing funds and for borrowing money that is needed to conduct daily business in the bank.

When business firms face a shortage of funds, they go to commercial banks to borrow.

When these member banks are short of reserves, they can borrow from the Federal Reserve Bank.

The Federal Reserve Bank simply credits the commercial bank's reserve account with the amount of the loan.

The rate of interest that the Federal Reserve Bank charges member banks for loans is called the DISCOUNT RATE.

The Reserve Bank can raise or lower that rate with the approval of the board of governors.

Raising the discount rate to member banks will in turn cause them to raise interest rates to their own customers.

Lowering the discount rate will allow member banks to offer lower interest rates to their customers.

OPEN-MARKET OPERATIONS

The Federal Reserve System, acting as the fiscal (money) agent for the federal government as well as the chief instrument for controlling the supply of money, buys and sells short-term government securities through open-market operations.

These purchases and sales are made through dealers who represent investors interested primarily in Treasury Bills (three-to-six month loans).

Commercial banks often hold such securities as secondary assets and frequently buy and sell them to adjust their own reserve positions.

RESERVE REQUIREMENT

The Board of Governors of the Federal Reserve has the power to raise or lower the reserve requirements (the percentage of a bank's total deposit that it must keep in its own vaults) of member banks within certain limits.

Under the original Federal Reserve Act of 1913, specific and inflexible reserve requirements were established.

Changing the reserve requirements can be a very powerful tool, and thus it must be used with caution.

For example, a bank has $100,000 in assets.

If the legal reserve requirement is 10 percent ($10,000), it means that $90,000, or 90 percent of the bank's assets may be used for loans and to pay out to its customers.

A 20 percent reserve ($20,000) means that $80,000 (80 percent) of the bank's assets are available for demand deposits or for loans.

A demand deposit is an account in a commercial bank on which checks can be written and from which money can be withdrawn without any advance notice.

Demand deposits make up the largest part of our money supply.

MARGIN REQUIREMENTS

When people buy stock through their broker, they may pay a part of the purchase price and borrow the rest, using the stock as collateral.

The percentage of the total price that must be paid at the time of purchase is called the margin.

The Board of Governors of the Federal Reserve has the power to determine what the margin will be for the banks.

When the margin requirement is set at 50 percent, buyers must pay for half the amount of their stock purchase and may borrow the remainder.

If the board decides there is danger of inflation due to excessive speculation of the stock exchanges, it may raise the margin requirement.

Such a case occurred in 1958, when margin requirements were raised to 90 percent. In 1962, the margin was dropped to 50 percent.

Summary

Monetary and fiscal policy are very interesting and can be stimulating to follow.

Many young people choose a career in finance or banking after learning about economics and the interaction of some of these concepts.

After all, it is your life and your money!