A1. Introduction: Macroeconomic Policy

  Summary of contents in textbook

There are two powerful tools our government and the Federal Reserve use to steer our economy in the right direction: fiscal and monetary policy. When used correctly, they can have similar results in both stimulating our economy and slowing it down when it heats up. The ongoing debate is which one is more effective in the long and short run.

Fiscal Policy

Fiscal policy is when our government uses its spending and taxing powers to have an impact on the economy. The combination and interaction of government expenditures and revenue collection is a delicate balance that requires good timing and a little bit of luck to get it right. The direct and indirect effects of fiscal policy can influence personal spending, capital expenditure, exchange rates, deficit levels and even interest rates, which are usually associated with monetary policy.

Monetary Policy

Monetary policy consists of the actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault (bank reserves). The Federal Reserve is in charge of the United States’ monetary policy.

The Federal Reserve System

The Federal Reserve System is the central bank of the United States. The 10th edition of The Federal Reserve System Purposes & Functions details the structure, responsibilities, and aims of the U.S. central banking system. The Federal Reserve System performs five functions to promote the effective operation of the U.S. economy and, more generally, to serve the public interest. It includes three key entities: the Board of Governors, 12 Federal Reserve Banks, and the Federal Open Market Committee.


Seal of the United States Federal Reserve System

Flag of the United States Federal Reserve

Janet Yellen, Chair of Federal Reserve

Structure of Federal Reserve System

Functions and purposes of Fed


Historical US GDP per capita, 1929–2011

Historical US GDP per capita, 1929–2011

Economic Sectors in USA (BBC 2011)


  Supplementary readings

Fiscal Policy – the Keynesian School

Fiscal policy is often linked with Keynesianism, which derives its name from British economist John Maynard Keynes. His major work, “The General Theory Of Employment, Interest And Money,” influenced new theories about how the economy works, and is still studied today. He developed most of his theories during the Great Depression and Keynesian theories have been used and misused over time, as they are a popular and are specifically applied to mitigate economic downturns.

While fiscal policy has been used successfully during and after the Great Depression, the Keynesian theories were called into question in the 1980s after a long run of popularity. Monetarists, such as Milton Friedman, and supply-siders claimed that the ongoing government actions had not helped the country avoid the endless cycles of below average gross domestic product (GDP) expansion, recessions and gyrating interest rates.

Monetary Policy – the Money Supply

Broadly, there are two types of monetary policy, expansionary and contractionary.

Expansionary monetary policy increases the money supply in order to lower unemployment, boost private-sector borrowing and consumer spending, and stimulate economic growth. Often referred to as “easy monetary policy,” this description applies to many central banks since the 2008 financial crisis, as interest rates have been low and in many cases near zero.

Contractionary monetary policy slows the rate of growth in the money supply or outright decreases the money supply in order to control inflation; while sometimes necessary, contractionary monetary policy can slow economic growth, increase unemployment and depress borrowing and spending by consumers and businesses. An example would be the Federal Reserve’s intervention in the early 1980s: in order to curb inflation of nearly 15%, the Fed raised its benchmark interest rate to 20%. This hike resulted in a recession, but did keep spiraling inflation in check.

Purposes and Functions of The Federal Reserve System

It performs five general functions to promote the effective operation of the U.S. economy and the public interest.

The Federal Reserve

  • conducts the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy;
  • promotes the stability of the financial system and seeks to minimize and contain systemic risks through active monitoring and engagement in the U.S. and abroad;
  • promotes the safety and soundness of individual financial institutions and monitors their impact on the financial system as a whole;
  • fosters payment and settlement system safety and efficiency through services to the banking industry and the U.S. government that facilitate U.S.-dollar transactions and payments; and
  • promotes consumer protection and community development through consumer-focused supervision and examination, research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations.

The Three Key Federal Reserve Entities

The Federal Reserve Board of Governors (Board of Governors)

The Federal Reserve Banks (Reserve Banks)

The Federal Open Market Committee (FOMC)

  Useful websites

【10 Minutes Crash Course:Economics】Monetary Policy


【10 Minutes Crash Course:Economics】Fiscal Policy


Wikipedia – Monetary policy


Official website of the Fed


A useful website which can help us learn about economics