Question

(a)Which is more effective between fiscal policy and monetary policy in tacking inflation and tackling economic recession? (b) Discuss fully the relationship between the quantity theory of money and money demand

Answer 1

A)

Generally both of these policies are used to address the problem of inflation and recession. Monetary policy can be executed quickly. But Keynesian argues that monetary policy is not as effective as fiscal policy. Liquidly trap condition renders monetary policy ineffective while dealing with recession. Further external lag effects are larger for monetary policy.

But for reining in the inflation, monetary policy is preferred over the fiscal policy. The great recession of 2008, highlights that both policies must be followed simultaneously to get quick outcomes.

B)

Quantity theory of money argues that money is demanded only for the transaction purposes. Hence when quantity of money increases, it gets converted into the rise in the price level only. The value of money decreases.