Economic factors often influence the policy changes that governments choose to implement. Government policy, particularly in the United States, has always had a significant impact on economic development, the formation of new company organizations, and the performance of financial markets.
In the widest sense, economic activity in a nation reflects what individuals, firms, and governments wish to purchase and sell. Because the United States has a capitalist economy based on free market principles, it is theoretically the choices of consumers and producers that shape the economy.
The government may opt to restrict some parts of economic activity in order to engineer economic development or to avoid future unfavorable economic situations. In general, a government’s active engagement in reacting to and affecting a country’s economic conditions serves to preserve and advance the general public’s economic interests.
Having a track record of economic development is sometimes an essential factor for individuals in positions of power (especially if they are in a position of seeking re-election). Many studies in the United States have shown that the economy is a key factor influencing how people vote (specifically in the U.S. presidential election).
Strong economic growth is often associated with more job creation, greater salary growth, improved financial market performance, and higher corporate profits.
The federal government may react to economic activity in two ways to guarantee healthy economic growth: fiscal policy and monetary policy.
One of the most frequent methods for a government to exert influence on a country’s economic activity is to change the cost of borrowing money. This is usually accomplished by decreasing or rising the federal funds rate, which is a target interest rate that affects short-term debt rates such as consumer loans and credit cards. The Federal Reserve raises the federal funds rate to stifle economic development and lowers the federal funds rate to stimulate it.
The act of the Federal Reserve purchasing and selling government assets is another kind of monetary policy. When the Fed purchases a security from a bank, it injects cash into that bank, increasing the money supply. It may also sell securities to withdraw cash and reduce the money supply.
The government may also establish policies that alter expenditure, change tax rates, or create tax breaks. When it comes to government budgets, the government decides whether or not it wants to spend more money than it expects to receive. This method of reviewing government expenditure seeks to foster economic success or to calm an overheated economy.
Instead of concentrating on how the government spends money, mainstream fiscal policy focuses on how the government gathers money. Offering tax breaks, greater tax credits, or lower tax rates reduces the economic burden on residents and supports economic development. Tax cuts or increases hamper economic growth.
The Federal Reserve System oversees monetary policy in the United States. The Federal Reserve System, usually known as “the Fed,” is the United States’ central bank. Congress established the Fed in 1913 to regulate the money supply and actively employ policy to react to and affect economic circumstances. 4
The Fed changes the interest rate at which banks lend to one another. (This expense is then passed on to customers.) The Fed may cut interest rates to keep borrowing inexpensive, credit readily accessible, and consumer (and corporate) confidence high. In contrast, the Fed may opt to raise interest rates in a robust economy or in reaction to inflationary concerns—price increases that occur when individuals have more money to spend than what is available to purchase.
The Federal Reserve, an autonomous organization officially not part of the Federal government, sets monetary policy, which is one of the two ways governments may influence in the economy. Fiscal policy, on the other hand, need political involvement and majority support (for items not issued by executive order by the President).
Prior to the creation of the Fed in 1913, the U.S. had experienced several severe economic disruptions as a result of massive bank failures and business bankruptcies. As an institution, the Fed was tasked with ensuring financial stability in the U.S. economy.
After the Great Depression, the greatest threat to the stability of the U.S. economy were recessionary periods: periods of slow economic growth and high unemployment rates. In combination, these two factors created a sustained period of decline in the gross domestic product (GDP).
In response to this, the government increased its own spending, cut taxes (in order to encourage consumers to spend more), and increased the money supply (which also encouraged more spending).
Beginning in the 1970s, a different economic reality emerged. This expansionary economy with substantial money supply growth led to a sustained period of high level of inflation.
In response to these economic factors, the U.S. government started focusing less on combating recession and more on controlling inflation. Thus, the government enacted policies that limited government spending, reduced tax cuts, and limited growth in the money supply.
At this time, the government also shifted away from its reliance on fiscal policy—the manipulation of government revenues to influence the economy. The fiscal policy did not prove effective at addressing high levels of inflation, high levels of unemployment, and vast government deficits.
Instead, the government turned to monetary policy—controlling the nation’s money supply through such devices as interest rates—in order to regulate the overall pace of economic activity.
Since the 1970s, the two main goals of the Fed have been to achieve maximum employment in the U.S. and to maintain a stable inflation rate. This dual mandate is difficult to achieve; by combating one of the goals, it becomes more difficult to fight the other.
While outside events may influence economic activity, governments use economic means to enact changes as they see fit. This may include changes to tax policy, adjustments to the federal funds rate, fluctuations in the money supply, or alternations to government spending.
The topic of whether the government should interfere in the economy is highly philosophical. Some feel it is the obligation of the government to safeguard its people from economic hardship. Others feel that free markets and free trade will self-regulate as they are designed to.
The government has an intrinsic interest in ensuring its people’ well-being. Due to global circumstances, the government may deem it necessary to implement specific laws to protect the quality of life for its population. In addition, the government may establish laws to promote economic well-being and fairness across socioeconomic strata.
The government interacts with the economy primarily via two channels. The government regulates current interest rates and makes debt acquisition simpler or more difficult via monetary policy. The government regulates expenditure levels and resource allocation via fiscal policy.
One of the most frequent methods for a government to exert influence on a country’s economic activity is to change the cost of borrowing money. This is usually accomplished by decreasing or rising the federal funds rate, which is a target interest rate that affects short-term debt rates such as consumer loans and credit cards.
The government (1) establishes the legal and social framework within which the economy runs, (2) preserves market competition, (3) provides public goods and services, (4) redistributes income, (5) compensates for externalities, and (6) takes some steps to stabilize the economy.
The government impacts economic activity in the United States via two channels: monetary policy and fiscal policy. The government uses monetary policy to control the money supply and the level of interest rates. It exercises its ability to tax and spend via fiscal policy.
The benefits of a command economy include low levels of inequality and unemployment, as well as the shared goal of replacing profit with equality as the major motivator for production. Command economies include disadvantages such as a lack of competition, which may lead to a lack of innovation and efficiency.
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