Macroeconomics Part 3: Economic Policy

Written by: Caroline Kim

May 24, 2025

This week, we’ll close out discussion on an introduction to macroeconomics. In the final part of this blog trilogy, we'll cover the topic of economic policy- fiscal policy, monetary policy, and exchange rate policy. Each has unique factors that can influence the economy as a whole. I learned and studied much of the information that will follow from my past macroeconomic course I took at the University of Florida under Prof. Thomas Knight. The class was insightful, beneficial, and I hope to share some of the knowledge through this blog.

We’ll start off by discussing fiscal policy: the use of the federal budget to pursue a macroeconomic objective. Fiscal policy is a joint exercise conducted by congress and the president, and it often involves taxes and government spending. To understand fiscal policy we first need to lay the groundwork on the federal budget, receipts, and outlays. The federal budge consists of receipts (taxes) and outlays (government spending). Receipts mainly comprise of personal income tax, social security tax, other payroll taxes, corporate income tax, and more; on the other hand, outlays comprise of transfer payments (support for low-income families), payment for goods/services, and interest payment on the federal budget. If these tax receipts are greater than outlays, the government is running a budget surplus, whereas the government would be running a budget deficit if the outlays are greater than the receipts. Within fiscal policy lies two variations- automatic and discretionary policy. Automatic policy refers to automatic functions such as tax receipts increasing as household income increases or spending on needs-tested programs increasing when GDP decreases. Discretionary fiscal policies require action such as reducing personal income tax or reducing capital gains tax. These policies can impact the labor market, real economy, market for loanable funds, and more. 

Now, we’ll shift our discussion to the next economic policy: monetary policy. Monetary policy involves action by the federal reserve system, and has 3 tools: open market operations, reserve requirement, and discount policy. To open up this topic, we’ll first define the monetary base as the total amount of potential reserves in the banking system. Open market operations can involve open market purchases, where the government securities are bought. Here, the NY Fed pays for these purchases by raising the balance on the banks’ reserve account; this results in the monetary base growing, banks being able to make more loans, and increases in the money supply. Similarly, open market sales follow a similar procedure with outcomes such that the monetary base shrinks, and the money supply shrinks. The second monetary policy tool involves the reserve requirement (the minimum fraction of deposits that banks must hold as reserves). Resembling fiscal policy, monetary policy impacts the market for reserves, the market for money, the market for loanable funds, the real economy, and more. 

Last but not least, we’ll dive into the exchange rate, which is the price of one unit of that currency, denominated in units of another currency in the foreign exchange markets. Some important terms include appreciation and depreciation. In the context of this discussion, a currency is said to have appreciated when its exchange rate rises (ex. The price of  a 1 euro rises from 1 dollar to 2 dollars); similarly, a currency is said to have depreciated when its exchange rate falls. The demand for U.S. dollars is downward sloping because as the price of a dollar rises, U.S. exports become more expensive for foreign households (who then decide they need fewer dollars); as the price of a dollar rises, currency traders will see less opportunity for earning a profit. On the other hand, the supply of U.S. dollars is upward sloping, because as the price of a dollar rises, American households and firms will find imports from abroad more affordable (to import more goods and services they must supply more dollars); as the price of a dollar rises, currency traders will be more likely to  sell the dollars that they are currently holding. The demand and supply for the U.S. dollar can be influenced by the demand by foreign households/firms, U.S. real interest rate relative to foreign interest rates, expected future exchange rate, and real GDP growth. Exchange rate policy methods include market/floating exchange rate, managed float, and pegged/fixed exchange rate, each functioning in slightly different ways. 

These economic policies play a key role not only in how the U.S economy functions, but also how foreign economies can be impacted. Economic policies and economics as whole is a cornerstone to a successful society, and it is a topic I’d love to continue learning and sharing about!

Sources:

Professor Thomas Knight - University of Florida Spring 2025 ECO2013