Monetary and Fiscal Policy Explained - YouTube

well hey there

in this video we're going to talk about the difference between monetary and

fiscal policy and you're likely familiar with these two concepts or at least

heard of them two of the more important concepts in economics and the focus

really is on trying to improve the health of the economy now the government

is obviously interested in certain indicators as GDP and unemployment rates

and consumer spending in a variety of others

so the focus here really is on trying to move those metrics in a way that

represent the economy is improving

so the focus is very similar we're trying to improve the health of the

economy

now the means to which we do that is how these two policies different we pull

different levers to try and help out and improve economic conditions again as

reflected by a variety of economic indicators such as unemployment gdp

consumer spending to name a few

so I don't want to get it to the intricacies surrounding the specific

tactics that are utilized but i do want to focus on the kind of the general

differences between these two very important economic policies

so the first thing we're going to talk about is monetary policy now monetary

policy involves using two specific levers to try and improve the condition

of the economy

the first of which is what we call interest rates

and the second is known as the money supply now

interest rates represents both what banks essentially charge on loans but

also what we receive an interest so if you have a savings account or a CD the

money that's paid on that account largely is affected by the prevailing

interest rates which although aren't set entirely by the Fed in some way they

certainly influenced them through the purchasing of securities and those types

of things

so the general idea is by lowering interest rates

what the Federal Reserve can do is essentially make it more advantageous

for people to get loans and then of course spend them which injects money

into circulation which of course gets invested into hiring employees and

purchasing goods and its kind of this kind of cyclical kind of event that

takes place so interest rates are really important you probably are familiar with

a couple of specific interest rates

things like what we call the discount rate which represents the actual money

that is loan to banks so the federal reserve of course one of their major

roles is the kind what we call the bankers Bank and so if a bank needs to

get over night monies they can go to the Federal Reserve and they can go to

what's called the discount window and then pay whatever prevailing rate that

is currently it's relatively I think maybe a quarter to half a percentage

point which can again kind of reflects the idea that i'm trying to as the

federal reserve

you know I want to facilitate spending if I want to pull back on spending if

I'm concerned about potentially inflation and the economy is getting

growing too quickly then I can of course raise that interest rate the second

interest rate will be what we call the Fed Funds rate

and this particular rate although it isn't set specifically by the Fed

they've set what's called a target and the Fed Funds rate you're probably

familiar is the rate that banks can loan to one another so banks will usually

keep reserves with the federal reserve will with at least their federal reserve

branch

so for example at least here because we're in California our closest federal

reserve branch in San Francisco so banks in this area and throughout a lot of the

West will hold reserves with the Federal Reserve they can keep that money on hand

and the fed will actually pay an interest rate to hold those monies

but what the banks can do is they can lend money to one another for a

specified interest rate again this is kind of you know that the bank's agree

to on themselves

however the Fed does set a target on what is considered to be reasonable as

well so that's interest rates the other aspect is the money supply or the amount

of money that's in circulation

so what the Federal Reserve can do is it can essentially take the amount of money

so say this represents 100 million dollars which is very small

typically with the Fed we're talking about billions and and really they have

trillions of dollars on their books but just as an example let's say there's a

hundred million dollars in circulation

this means that the amount of money available to consumers like your eye is

100 million so that's how much we can access through banks remember banks of

course our kind of the distribution mechanism for the Fed when the Fed wants

to create money it doesn't actually physically create it

it simply transfers money on to the books of banks banks and in turn will

make loans and then of course we can get loans and then spend that particular

money

so in this case what the Fed can do with the supply of money is it can go ahead

and it's going to go ahead and increase this amount and so maybe it increases it

an extra 25 million dollars

well this is now an extra 25 million dollars it's available in circulation

for people like you and I to acquire in terms of loans filtered down through the

bank's we go into our local bank or credit union apply for a loan and then

we can take these monies and then spend them on homes cars computers

whatever good that we would that we want to obtain so this is a really

interesting thing because by increasing the supply of money

the Fed essentially increases the availability or the supply of that which

in turn gives people the opportunities to acquire those funds if they get spent

of course that's revenues for businesses and if enough of that takes place than

businesses have needs to hire in those types of things

so those are the two policies they're related specifically into monetary

policy we can talk more about specifics in a future video now in fiscal policy

we're actually looking at accomplishing the same thing as monetary policy what

we do it differently now we're monetary policy is controlled by the Federal

Reserve fiscal policy is controlled by the executive and legislative branches

so in this case you know the legislative branch can recommend policies and those

types of things we have kind of that checks and balances system so one can't

do without the other so fiscal policy is going to take the two forms one

it's going to take the form of government spending and two it will take

the form of Taxation

so government of course is responsible for two things one the money that it

spends government has a huge budget and then it will in turn use that budget to

support certain areas of the economy that it thinks needs to be supported

taxation of course represents what we as consumers will pay on our taxes but the

the Fed or the government can also use this as a way of giving increased money

is in the hands of individual consumers so we will of course spend it

one thing that you're probably familiar with is at least in the US we have a

very terrible savings rate so if we get money the chances of us saving is very

slim

I believe it fluctuates but it can range anywhere from 12 maybe two percent it

increased a little bit after the latest recession and await just as people were

trying to kind of improve their personal balance sheets but it usually hovers

around that percentage and so that shows you that if you got a hundred dollars

for example you would save maybe a dollar to the rest of it you're going to

spend the government knows this and understand that if we give money to

consumers the chances of them saving it is going to be very very low

so let me give you an example of this government spending makes sense because

the government can in turn go and buy something from particular industry and

then can inject money in the economy that way

one interesting thing that would make the distinction of is under fiscal

policy or merely talking about a redistribution of existing monies

so we're not creating new money monetary policy involves the creation of new

money and that big as the example that I gave you before is the Federal Reserve

engages in a transaction digitally puts money on the books of banks that didn't

exist before and then in turn that's filter to the banks with fiscal policy

we're not creating new money we're merely taking it from a source so if we

tax one group of consumers and then we re distributing it as a way of improving

economic development so that's an important distinction that you get

between the two

now one thing you can do with taxation for example is what we call the payroll

tax holiday

and this took place several years ago and it was in response to economic

recession of 2008

I believe this one into effect in 2009-2010 and so what happened is if you

look on your payroll taxes you pay a social security tax of 6.2 percent so

what the what the government did is it decreased this tax rate and so instead

of paying six point two percent

we paid I believe you paid for . to instead so it was a two percent savings

so by doing so what happened was everybody's paychecks you probably

noticed this got a little bit bigger and you didn't get a raise but it was less

in taxes and so by doing so what the government is doing is using the levers

of taxation for the purpose of you know reinvesting money into the economy

because if people slowly see that they have more monies

they're going to spend more in terms of you know essentials and groceries and

those types of things at least that's the general logic behind it

if it's a larger sum of money people would be more likely to save it

now you can argue that maybe this policy wasn't great but this is an example of

fiscal policy that was of course lessening social security taxes going in

and you can make the argument of course that maybe we should be paying into

Social Security given its not essentially the strongest thing

financially but that's an example of a fiscal policy the payroll tax holiday of

2009

so that's the two differences so the key things again remember that both of them

are attempts to influence the economy in a positive way they do a little bit

differently

monetary policy specifically with interest rates in the money supply

fiscal policy specifically with money that government spends as well as

taxation

but the intent is very similar we're trying to take money put it in the hands

of those people that are going to spend it so they can spend it goes into

businesses businesses have no demand for goods and services they hire now people

have more money and so you get kind of this cycle that takes place

but the government tries to use this as the starting point to create that cycle