Monetary and fiscal policy and its effect on business and economic cycles. Now, monetary and fiscal policy are used during various phases of the business cycle to try to moderate or expand economic activity. And we'll take a look at the two examples, both expansion and contractionary. First of all, expansionary. Once it's identified, the central bank enters into a tightening or restrictive policy environment. And what does that mean? Well, there's a bit of review. They could raise rates, interest rates, they could increase reserve requirements that they require by banking institutions, or they can sell treasuries and take money out of the economy. In all three of these instances, the essential bank is decreasing the money supply. And since the money supply has a direct effect on interest rates, this decrease in the supply will tend to have an increasing effect on interest rates in an attempt to moderate the economy. On the fiscal side, also, it's restrictive. The government will raise taxes or decrease spending, right? If they're raising taxes, there's less disposable income, slows down output. If they're decreasing spending, they're spending less on infrastructure, also, in a name to decrease or slow down the growth of output. Contraction or recession. Now, once a potential recession is identified by the central bank, they will attempt to ease monetary policy or loosening is another word that you may use. And just like the flip side of an expansion, here we are going to lower rates, decreased reserve requirements and buy treasuries to put more money out there in an economy and increase the money supply, having a direct relationship on rates. And in this case, it would lower rates, trying to encourage companies to invest more in their businesses, trying to encourage consumers to spend more to raise the overall output of the economy. On the fiscal side, easing and loosening policy, the government will lower taxes, lower taxes putting more money in consumer's pockets and in corporations, profit line, encouraging more investment and more spending. And they also increase their own spending on infrastructure which will create more jobs and hopefully, turbocharge the economy, at least in the short term. Now, some key points about inflation and another related terms that are at key determinant as essential bank and the government decide potential actions both on the monetary and fiscal policy side of things. First of all, inflation, obviously, it's a word we all know, it's when prices increase. But it's also when output is increasing and unemployment is falling. And that usually seen during the expansion phase of the economic cycle. Deflation also pretty intuitive. It's when prices decline. And what causes prices decline. Well, it's when output is decreasing, when economic activity is decreasing and unemployment is rising. So, folks have less money in their pocket, fewer jobs, and causing prices of goods to decline. And this usually happens during recessions or contractionary phases of the economic cycle. Now, you know, two other not so intuitive terms that you'll also hear. First, reflation. Now, reflation can be defined as utilizing both fiscal and/or monetary policy with a goal to expand output. And it's usually enacted in periods that we are seeing deflation and it's meant to counter deflation. The policy will be easing in nature, both on monetary and the fiscal side. It could also be used to identify a recovery that inflection point from the trough into expansion as we see prices in economic activity increasing. Stagflation. Here, declining GDP or economic growth is accompanied with rising prices and inflation. And this is a bit counterintuitive and is not a typical relationship. Well, how could that happen? Well, economists believe that in theory, stagflation can be caused by a supply shock, which means a sudden decrease in the availability of a commodity, for example. An example is, a sudden increase in energy or oil prices because of limited supply. And this would reduce the ability of the economy to grow. And it can also be caused by poor economic policy decisions by governments and central banks leading to a stagflation environment.
