Two types of tools are being utilized by the economic policy makers to affect the economy and these two tools are actually two policies, i.e. the fiscal policy and the monetary policy.
Fiscal policy is related to government revenue collection and its spending like when the demand gets low in a certain economy then a government comes forward to increase the demand with its spending. It can decrease the taxes too for stimulating the demand. Monetary policy refers to the supply of money basically and it is controlled with the help of factors like interest rates and the reserve requirements. For example the interest rates can be increased to control the supply of money in case of inflation.
These two policies apply only in the market economy.
What are the policy tools?
Both these policies can be exercised as contractionary or expansionary. They will be expansionary when measures are governed to increase the growth and GDP and they are called contractionary when measures are taken to control the overheated economy.
Regulating and the executive branches of a government manage the policy and in US President and the Congress are responsible for passing the law.
What is the Pro-cyclical and Counter-cyclical Fiscal Policy?
An economics professor who belongs to Harvard University claims that a good and understandable fiscal policy is always countercyclical. At the time of economy boom, the government must run a surplus and in recession it must exercise deficit. There is not found any good reason to follow the type of pro-cyclical fiscal policy. The main disadvantage of this policy is that it is very destabilizing policy and it makes the situation so bad and it raises inflation.
What is a monetary policy?
This policy is exercised and managed by the Central bank and in case of US it is handled by the Federal Reserves. Government appoints the federal chairman and an oversight committee is also present in the congress for the Fed. A monetary policy utilizes many tools that are as follows:
First thing is the interest rate. It is known as the price of money or the cost of taking money. A central bank can raise or lower the interest rate to contract and expand the borrowing. When the rate is low, the people would like to borrow more or vice verse. Reserve requirement is a tool in which all banks and agencies are responsible to hold a certain amount of money as a reserve. In this way, the amount of giving loan can be controlled. Feeble economies can make a decision to peg their own currency against the strong currency. The Fed can invest money in the economy in the form of purchasing the government bonds. This is quite handy tool.
Criticism on these policies:
Criticism is often done on fiscal policy versus monetary policy issue. The liberal economists argue that the actions of government always result in the form of unproductive outcomes and some say that monetary policy is not helpful. So, it is a controversial issue that which one is the best.