Fiscal and Monetary Policy Essay
Governments can use both fiscal and monetary policies to move the economy from a recessionary or expansionary gap. Fiscal policies include increased or decreased government spending, increased or decreased taxation; on the other hand monetary policies include increased or decreased money supply, changes in interest rate, etc.
One of the tools of fiscal policy is government spending, the initial equilibrium is represented by the point E. With increased government spending, the IS curve shifts to the right and new equilibrium is reached at point E’, with increased level of output and higher interest rate.
Monetary policy can help the economy back to the long run equilibrium. Let the initial equilibrium …show more content…
The major advantages of monetary policy include: (i) Monetary policies have short gestation periods; they can be implemented with short time lags. (ii) Monetary policy is conducted by the Central Bank of the economy, which can be taken with much political neutrality. (iii) Can be very flexible and does not lead to budget deficit.
The major disadvantages of monetary policy on the other hand are: (i) Monetary policy cannot be directed for direct spending in the areas of infrastructure and spending may be wasted in speculations. (ii) The policy is applicable nationally, cannot be applicable to specific states or areas.
Based on your analysis, does conducting fiscal and monetary policy result in the same impacts on inflation or output levels? Be sure to talk about the tradeoffs (or lack thereof) that exists between inflation and output in the short and long run.
In the short run society faces a trade-off between output and inflation. For example, if the monetary policy makers ( Bank of Canada or any other Central Bank) and government wishes to expand the economy by shifting the aggregate demand curve (Increases in the money supply, increases in government spending, or cuts in taxes expand aggregate demand), then that increases output but that comes with increasing price level or inflation. On the other