Video Transcript: Lesson 2

In this video, we'll be discussing fiscal and monetary policy as it relates to  macroeconomics. Governments have two broad categories of policies available  to affect the level of aggregate demand in the economy. These are known as  fiscal policy and monetary policy. Fiscal policy is defined as the set of a  government policies relating to its spending and taxation rates. So those will be  determined by in the United States by the Congress. They determine what  capital expenditures are made and how taxes are regulated inside our domestic  economy. Now, direct taxes and indirect taxes can be raised or lowered to alter  the amount of disposable income consumers have. Obviously, if taxes are  raised, consumers will have less cash to spend on necessities or luxuries,  whatever they would like. Same thing. If taxes are lowered, consumers will have much more disposable or discretionary income to spend or reinvest. Now,  contractionary fiscal policy is to decrease the amount of disposable income,  right? So if they're going to contract the if they're going to contract fiscal policy,  to they're going to decrease the amount of disposable income that a consumer  has to spend. So obviously, in this position, they will raise taxes. Where if you  have an expansionary fiscal policy, you want to increase the amount of  disposable income that consumers have. You want to be able to expand the  economy, allow consumers to spend more. Therefore, you'll lower taxes, and  then you'll be able to promote a a growth policy inside your domestic economy.  Now, if the government would like to encourage greater consumption, then it can lower income taxes to increase disposable income. This will likely lead to an  increase in aggregate demand. Now, aggregate means the sum total. So, if we  lower taxes, the sum total of the consumers in that economy will have more  availability to spend their discretionary income, or reinvest, or even potentially  save it. So, if a government would like to encourage greater investment, then it  can lower corporate taxes so firms enjoy the after-tax profits that can be used  for reinvestment. This is likely to increase aggregate demand as well. So, if we  are lowering corporate income taxes, that means the corporations will have  more cash to reinvest back into their business, which will allow them to grow  more jobs and sustain a profitability model moving into the future. Now,  governments have major investment projects themselves and may increase  their spending in order to improve or increase public services. This will likely  increase aggregate demand as well. So if the government is also reinvesting  back into local, regional, or national economies, right? This will also raise the  level of aggregate demand because government services will like more than  likely increase in quality, efficiency, and effectiveness, which will allow  consumers to navigate whatever it is that they're using that the government has  invested in. Now, the definition for monetary policy is a set of official policies  governing the supply of money in the economy and the level of interest rates in  an economy. So you know, if if if the government wants to expand the economy,  they are going to inject more cash into the economy. Like if you will remember 

the 2008 financial crisis in the United States, when we had the TARP bailout  program, during the TARP bailout program, the government had a 750 billion  dollar infusion of cash into banks, so that they would be able to loan that. Money out to consumers because credit at that time was so tight that banks were not  willing to lend the capital that was needed to continue the lifeblood of the  economy. Now, so this was a expansionary policy and expansionary policy for  monetary policy by the United States government at this time because we  needed to have a cash infusion to be able to allow banks to lend that money so  we could continue to not just stabilize our economy at that time but hopefully  grow what we could in the midst of a severe recession. Now, obviously, that  example was on an extreme end, but governments will more than likely use the  policies of contraction and expansion over time. So, if if they want to control the  the growth in the economy, they want to slow the economy down. You know they will tighten up their monetary policy. They will bring rein in some of that cash  that's out there in the free cash flow inside the economy, usually by the central  bank having a reserve requirement increase. So therefore, banks will have to  keep more cash with the Federal Reserve in order to meet their requirement.  Therefore, slowing down the amount of lending that is happening inside the  economy, which will slow the economy down because we don't always want an  economy to be red hot. We want to make sure it's a balanced economy growing  at a steady pace. If it grows too too fast, like we saw in 2006, 2007, you know  we have a potential opportunity for disaster if an economy gets going way too  piping hot. Now the central bank's interest rates affect borrowing at all levels of  the banking system. So if obviously if interest rates are higher, you will have less consumers coming in to want to obtain a loan because they're going to pay back more cash than they would if the interest rates were still low. So you'll see a rush for capital once interest rates start to come down. People want to execute those  transactions with lower borrowing costs. So you'll see when rates come down,  people will borrow more money. When rates go up, people will hold off on  borrowing money until the rates come back down, unless they absolutely have  to have the cash. Changes in the central bank's base rate can affect the level of  aggregate demand in an economy. So again, the base rate charged by a central  bank, which is in the United States the reserve requirement held at the Fed, this  fluctuation in reserve requirement will stop or expand, or diminish or expand the  amount of funds that a bank is willing to loan, or if the rates are high due to a  larger requirement by the central bank, then that will also put a damper on  consumers' willingness to go seek loans. Example to increase the demand, the  aggregate demand, the central bank might alter the base rate. Okay, the base  rate goes down, aggregate demand goes up. Right, so if the base rate for a loan for commercial real estate project goes down, the aggregate demand for loans  from that bank to invest in a commercial real estate project will go up. This is  known as expansionary or loose monetary policy, the base rate, if it goes up, the

aggregate demand will go down. This is also known as contractionary or tight  monetary policy.