Economic Crises and the Substituion of Fiscal Policy by Monetary Policy

Abstract

The paper discusses the latest economic crisis and the public policies used to mitigate the recession and improve the economic growth. The current target rate (monetary policy) is closed to zero since December 2008 with a new experimental policy (“quantitative easing”) to stimulate investment, growth, and employment. The abandonment of the fiscal policy and the current U.S. tax system, which reduces the disposable income and makes savings negative (dissaving or borrowing) has contributed to this slow growth of output and persistent unemployment. This policy has increased the debt of individuals and the low taxes on businesses have magnified the budget deficits and the national debt. Individuals are borrowing the present value of their uncertain future wealth to satisfy their current consumption and their high debt and low income raise the risk and this high risk premium increases the interest rate on uncollateralized loans, especially on credit cards. The U.S. government has to increase corporate taxes, which will lower the national debt; but at the same time, it has to reduce government expenditures (mostly, military expenditures and national defense), curbing inefficiencies, corruption, and increasing public investment (infrastructures). The public policies must be mixed policies (fiscal and monetary) to improve growth and employment first and then to reduce inflation and interest rates. The current one-sided monetary policy and the tax system need to be changed and become optimal, which are essential to improve social welfare, fairness, equity, justice, and to benefit the neglected middle class (the 90% of the population) in the country. This middle class works and pays just taxes and interest (redistribution of its wealth to government and banks), due to its low disposable income, high unemployment, and unfavorable monetary policy. Impoverishing the middle class will deteriorate the entire state of our socio-economic system and it might threaten the existence of the nation.    Keywords: Estimation; Time-Series Models; Consumption and Saving; Taxation; Government Expenditures; Interest Rates; Monetary Policy; Fiscal Policy JEL Classifications: C13; C22; E21; E43; E52; E62; H20; H50