Fiscal and monetary policy mix
Both monetary policy and fiscal policy affect the aggregate demand.
When the economy is at equilibrium state, that is, the aggregate demand and aggregate supply intersect each other at full employment level, the balanced budget would be more appropriate.
When the contractionary monetary policy causes a reduction in the aggregate demand through decrease in money supply, it reduces the level of investment, employment, and income. To reach the full employment level, deficit budget, that is, expansionary fiscal policy, would be suitable. This is because the expansionary fiscal policy increases the level of investment, which in turn increases the employment level and total output in an economy, thereby leading to an increase in aggregate demand. Hence, the economy reaches full employment equilibrium point.
When the expansionary fiscal policy causes an increase in aggregate demand through increase in money supply, it reduces the rate of interest; the reduction in interest rate increases the level of investment, employment, and income. To reach the full employment level, surplus budget, that is, contractionary fiscal policy, would be suitable. This is because the contractionary fiscal policy decreases the level of investment, which in turn reduces the level of employment and total output in an economy. This leads to a decrease in aggregate demand. Hence, the economy reaches its full employment equilibrium point.
From the above discussions, it can be concluded that the mix of monetary and fiscal policy depends on the given state of economy.
Accumulation of debt
U.S. government was facing weaker economic growth, which led to an increase in depression in the previous years; this was followed by an increase in structural budget deficit and actual budget deficit. The recession in an economy was accumulated with anti-recession policy, and it increased the total debt of the economy to $14 trillion.
Debt is owned by the government of United States, but eventually, this debt is passed to the citizen of United States.
The increase in debt will be a burden to the future generation of America because the increase in interest payment will be transformed as a higher tax rate. This higher tax rate will be incurred by the citizens of America.
Federal Bank lowers interest rate:
When the Federal Bank decreases the interest rate, the level of investment in an economy increases. Increase in level of investment increases, employment, output, and the income level. The increase in the level of income increases government revenue, leading to a reduction in the Budget Deficit.
Increase in the level of income increases aggregate demand in an economy. As aggregate demand increases, the Federal Bank implements a contractionary monetary policy by increasing the tax rate and reducing the government expenditure. This leads to decreases the level of investment, level of employment, output, and income. The decrease in the income in turn decreases the aggregate demand.
Impact on Budget Deficit
The increasing the tax rate and reducing the government expenditure then it leads to increase the government revenue and reduces the total expenditure. This would reduce the budget deficit.