Question

Define fiscal policy and then define monetary policy.
Explain how the government uses each policy when the economy is too hot and inflation is rising.
Then explain how each policy is used when the economy is in recession.

Answer 1

Solution:

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy.Monetary policy is the policy adopted by the monetary authority of a country that controls either the interest rate payable on very short term borrowing or the money supply.

Fiscal and monetary policies are useful in stabilizing the inflation situations. Let us see one by one.

Fiscal policy usage during inflation:

• There is reduction in government expenditure.
• There is increased in taxation.
• Public borrowing is increased
• Overvaluation of domestic currency is done.

Monetary policy usage during inflation:

• There is increase in bank rate.
• High cash reserve recquirement or ratio (High Crr)
• Sale of government bonds in the open market is done.
• There is consumer credit control.

During the recession period the banks and the people try to get greater liquidity ,so credit also contracts. Hence here the monetary policy helps in controlling the credit for the consumers.

During the recession the economic policies slow down hence the demand starts falling, the overproduction and future investment plans are also given up hence here monetary policies helps in controlling the situation by reducing the government investment and investing more in these so that the situation is under control.

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