Monetary and fiscal tools are used by the government to control economic conditions in the country. Monetary policy usually targets money supply in the market in order to control inflation. In some countries such as Russia and Brazil, governments may often force the mints to print extra currency to meet various expenses. This results in higher flow of money in the market which is unsubstantiated by gold reserves of that country. That leads to inflation and causes several problems due to macroeconomic instability.
However when inflation is kept in check, prices stay within consumer's reach, money market remains stable and other areas such as employment, interest rates etc. However while monetary policy is more dependent on market forces and consumer behavior, fiscal policies include governmental spending, taxation and interest rates. We must understand that fiscal measures are normally utilized in capitalist countries when economic conditions are beyond the control of normal market forces and when government intervention is desperately required. In some countries of the world, including Japan, fiscal measures play extremely important role in the economy whereas USA has been somewhat reluctant to make use of fiscal policies.
The two important fiscal measures are tax reduction and lower interest rates. When businesses stop producing adequate amount of goods and services, government encourages them by offering attractive incentives mostly in the form of lower interest rates. These rates make borrowing easier and induce producers to invest more in business to increase production level. However the important reason why producers stop producing during tough economic times is because of lack of consumer interest. Consumer spending shrinks dramatically and less is spent on goods and services, which automatically results in lower production. This is a simple demand and supply concept which becomes more pronounced during bad economic times.
The fiscal measures of tax reduction can induce consumers to spend more as their purchasing power increases. The government literally puts more money into the hands of consumers to encourage them to spend more which might result in higher production. However these measures do not always work but if carefully planned, they can have a good impact on economic conditions in the country. In the United States, for example, we noticed that government reduced interest rates 11 times after September 11, to increase consumer spending and raise borrowing activity (Berry, 2001). However it is believed that when fiscal measures are not carefully planned, no desired results can be achieved. This is what happened when frequent tax reduction announcements and cuts in fund rates failed to bring about any positive changes in business activity in the country and many corporation feel one after the other. Fiscal measures should therefore be adequately supported by other means such as increase in deficit and careful budget allocation or else exchange rate is seriously hurt as dollar tumbles against other powerful currencies including Yen and Euro.
This is an important concept which must be understood to see how fiscal measures affect value of dollar and how increase and decrease in the latter can affect the economic conditions. As we already mentioned above that tax reduction is not always followed by other important measures, this can negatively affect the value of dollar. If dollar becomes weaker, GDP growth suffers, as revenues earned from exports are not adequate which can have a profound impact on profits of business corporations in the country. While United States has been using both monetary and fiscal measures to control economic conditions in the country, it appears that its fiscal policies have been far more successful than monetary policy. Usually the main problem with monetary measures is that they can often lead to a huge drop in inflation, causing a major economic downturn. Inflation within limits is always more desirable than no inflation or deflation. For this reason monetary policy must always be carefully implemented for its negative effects can often outweigh its positive ones. Rate of inflation is checked with the help of Consumer Price Index (CPI). CPI is the index that keeps a record of changes in prices of good and services over a certain period of time.
US Bureau of Labor Statistics is responsible for calculating CPI by adding various industries in order to compute cost of living more accurately. Sine CPI includes "a basket of goods and services" this means that every good and service that an average American is likely to use is added to CPI and this obviously includes travel as well. U.S. Airline industry has attracted more attention in recent years than any other industry in the country and despite its numerous failures and many problems; this industry has emerged as a real survivor.
Let us now study the best practices of the Airline Industry to stay afloat in recent times. Three main practices were identified by Brock (2000) who feels that this industry has managed to avoid complete financial collapse during economic downturn of mid-90s by adopting these three strategies:
1) Domestic and international mergers and alliances;
2) Discriminatory pricing
3) Price cuts by major airlines
While alliances and mergers have helped many airlines survive in times of extreme economic slowdown, it was mainly the pricing tactics that worked for the biggest players in the industry. Brock maintains that "During the 1990s, the main carriers have repeatedly resorted to sharp, tightly focused price cuts that corral low-fare independent carriers and prevent them from obtaining and expanding competitive footholds in important routes and markets." This is true to some extent because in late 1990s and early 2000s there were complaints lodged by smaller airlines that major players in the industry were engaging in predatory pricing. Considering these complaints, the U.S. Department of Transportation (DOT) even considered issuing specific guidelines to define and regulate exclusionary pricing practices. But what we may not know is that DOT eventually decided not to publish these guidelines and a lawsuit against American airlines was dropped when no predation could be detected. Moreover, the court dropped all charges and decided the case in favor of American airlines. The court ruled:
'The government's claims in the present case fail because American did not price below an appropriate measure of cost, because it at most matched the prices of its competitors, and because there is no dangerous probability (even assuming below-cost pricing) of recoupment of American's supposed profits by means of supra-competitive pricing."
Secondly while this strategy may have had some impact on smaller carriers in the past but in recent years, emergence of many new small airlines suggests that predation is not one of the tactics used by bigger players to block new entrants. This is clear from the fact that many low fare airlines that entered the market in mid-1990s such as ATA, AirTran, and Frontier all managed to grow within a short span of time. 5 Similarly JetBlue which is also a relatively new airline became highly successful so it suggests that there may be unique pricing strategies adopted by key players but they are not predatory in nature.
One important practice that airlines have adopted is discriminatory pricing. This is where airlines differentiate between leisure and business travelers and sets price according to time of travel, age of the traveler, purpose of the trip, refund-ability etc. The prices on one route can vary substantially for various reasons. For example Southwest Airlines has 10 different prices for one same route and there is a large gap between the cheapest and the most expensive ticket. The Transportation Research Board (1999) justifies this price differences claiming that:
Price discrimination allows carriers to cover both the operating and capital costs of providing the schedule-intensive service desired by business travelers, while filling empty seats with leisure travelers whose low fares at least cover their incremental or marginal cost.