Question

a) Explain the difference between Fiscal Policy and Monetary Policy.

b) What could be done using Fiscal Policy during a period of high inflation?

c) What could be done using Monetary Policy during a period of high inflation?

Answer 1

(a): Fiscal policy is concerned with the taxing and spending actions of the government while monetary policy is concerned with two main areas – management of interest rates and total supply of money in circulation. Secondly while the fiscal policy is set by the executive and legislative branches of the government the monetary policy is set by the U.S. Federal Reserve.

(b): During period of high inflation the Fiscal Policy can be used to charge higher income taxes or to reduce the level of government spending. Both these actions will lead to reduction in aggregate demand and this will bring down the demand pull inflation.

(c ): During period of high inflation the Monetary Policy can be used to increase the interest rates. An increase in interest rates will increase the cost of borrowings and this will discourage spending. The impact will be lower level of economic growth and hence lower level of inflation.