Fiscal and monetary policy are fundamental tools used by the central bank and federal government in order to influence macroeconomic activity. While monetary policy is focused on controlling the money supply available in an economy, fiscal policy is used through government spending and taxation to influence conditions on a macroeconomic scale. As a result of the harsh effects on the economy that occurred as a result of COVID-19, the central government took swift actions under both the Trump and Biden presidencies to address a variety of problems caused by the pandemic, such as diminished economic activity and underfunded resources that were critical to recovery.
The first major move of the government in regards to fiscal policy was the $2.3 trillion Coronavirus Aid, Relief, and Economy Security Act (CARES Act) signed by former President Donald Trump on March 27th, 2020. The Act included a variety of crucial acts towards jumpstarting the economy after the initial shutdown, including a $293 billion one-time tax rebates, $268 billion unemployment benefits expansion, $510 billion in loans, guarantees, and backstopping to prevent corporate bankruptcy, $350 billion in small business loans, and $250 billion for hospitals and government funding. The CARES Act greatly increased aggregate demand, which is the total demand for goods and services within an economy at a given time. Aggregate demand is made up of four main components: consumption, investment, government spending, and net exports. The act was able to surge aggregate demand by stimulating the economy through increased government spending.
Another fiscal policy decision used to mitigate the effects of the pandemic on the economy was the Consolidated Appropriations Act of 2021. On December 28th, 2020, former President Donald Trump signed this $868 billion funding bill into order. This act mainly serves to include unemployment benefits until March 14, stimulus checks of $600 to select individuals, PPP (Paycheck Protection Program) loans, vaccine resources, and educational funding. The Consolidated Appropriations Act of 2021 increased aggregate demand through government spending and consumption components. Stimulus checks in the form of $600 to individuals who qualify allows for increased consumption of a variety of goods and services within the economy. Spending by the government on unemployment benefits and other resources for funding further reflects the use of fiscal policy for economic recovery.
The first major fiscal policy move under the new administration of President Biden was the American Rescue Plan, which was signed on March 11th, 2021. This plan provided another round of pandemic relief, approximately costing $1.8 billion. The American Rescue Plan focused on unemployment programs, more stimulus payments in the form of $1,400 checks to eligible individuals, state and local government aid, as well as vaccination and education funding. This plan increases aggregate demand once again through the use of government spending.
The Fed’s monetary policy with regards to the federal funds rate is critical to the expansion of the economy. The Federal Funds Rate is the interest rate at which major institutions borrow and lend to each other. The federal funds rate was lower by 150 bp (base points) in March 2021 to 0-0.25 bp. This decrease in FFR implies an expansionary monetary policy, meaning that the government wants to expand the economy through increased spending, indicating an expression of increased aggregate demand. The Fed has also reduced the cost of swap lines between major banks. The interest rate, which was a tool greatly used during the Great Recession about a decade ago, the Fed has stated that rates will “‘remain low’” until they feel as if the labor market has reached levels that were consistent with pre-pandemic times. This guidance on the interest rate is crucial to the success of the economy, as a low-interest rate will allow for increased investment by firms since they do not have to owe as much on their payments as early as opposed to higher interest rates, thus increasing aggregate demand. These policy decisions also resemble a decrease in aggregate supply through changes in inflationary expectations. The deliberate expansionary monetary policy, which is used to increase economic growth, also increases inflation through the increase of the money supply. In addition, increases in aggregate demand, which has been seen through a variety of monetary and fiscal actions, lead people to expect higher future prices, leading to increased labor and manufacturing costs.