Question

The primary objectives of macroeconomic policy is to promote rapid and stable economic growth while ensuring high level of employment and stability in general level of prices. Fiscal policy and monetary policy can both influence economic activity. Compare their effectiveness. define what are monetary and fiscal policies, and analyze the different tools they are using. Integrate multiplier concept and effect. To which extent is this coordination not only necessary but also feasible?

Answer 1

Demand Side Policies can be classified into fiscal policy and monetary policy. While the main motive of fiscal policy is to raise the aggregate output of the economy, the main motive of the monetary policies is to control the interest and inflation rates.

　

A fiscal policy means when government adjust spending to stimulate production or taxing used to influence and monitor the economy. Fiscal policy can be used to close the (a) recessionary gap and (b) inflationary gap.

1. Recessionary Gap:

Expansionary fiscal policy eliminates the recessionary Gap. In the Keynesian theory, an increase in government purchases, decrease in taxes, or both results to rightward shift in the aggregate demand curve, thus restoring the economy to its natural level to real gross domestic product (GDP)

2. Inflationary Gap:

Contractionary fiscal policy eliminates the inflationary gap. It behaves opposite of expansionary fiscal policy, decrease government purchases, increasing taxes, or both results to leftward shift in the aggregate demand curve, thus restoring the economy to its natural level to real gross domestic product (GDP)

Pros and cons are discussed as below:

Monetary policies are the actions taken by central banks to control the monetary as well as financial status with the goal of attaining low inflation and sustainable growth in the economy. The tools that are used by the central bank under monetary policies include the reserve requirements, discount rate, and the open market operations.

The main component of economic growth is investment and saving (IS curve). In the short run when the interest rate declines, investment demand increases, and this increase results to a multiplier effect on consumption. Consequently raises the capital stock and thus raises the full-employment national income and product. However in the long run neither fiscal nor monetary policy affects there is no impact on real variables. As in the long run, there is no impact on real variables thus as a result higher saving and investment has no effect on the rate of growth in the long run.

The rationale for the coordination between the fiscal and monetary policy derives from the interrelated nature of goals. Without effective policy coordination, financial instability could ensue, leading to exchange rate pressures, high interest rates, rapid inflation, and adverse impact on the growth of economy