Question

When is it appropriate to use monetary and fiscal policy to stimulate or stabilize the economy? b. When is it inappropriate to use monetary and fiscal policy to stimulate or stabilize the economy? c. What specific fiscal policy tools would you use to stimulate aggregate demand and how? d. What specific monetary policy tools would you use to stimulate aggregate demand and how? e. What is your conclusion, should policymakers use the monetary and or fiscal policy to stimulate aggregate demand? Explain briefly. Please do not copy an answer already posted on here and I will rate well! thank you This is my third time trying this please do not use the same ones already posted on chegg it does not help

Answer 1

Part 1) Fiscal policy should be used to stimulate or stabilize the economy when the economy is operating at low level of interest rate and income. This is because at low level of interest rate there is a lot of money that people have in their speculative balances. These balances can be drawn out for financing higher levels of transaction demand by a small increase in the interest rate.

On the other hand, at low level of interest rate and income there exists indifference among the people between holding money and buying bonds. As a result, any increase in money supply will be added to the speculative balances, which means monetary policy measure will have no impact on the income and interest rate. So, monetary policy should not be used when economy is operating at low level of interest rate and income.

Part 2) When the economy is operating at high levels of interest rate and income, then monetary policy will have the greatest impact on stimulating or stabilizing the economy. This is because, at high interest rate the speculative balances are squeezed to minimum by people, and most of the real money supply will already be financing the transaction demand. This means, the only thing that is putting limits on the income level to rise is the availability of money in the economy. So, an increase in the money supply will stimulate the economy.

On the other hand, at higher levels of interest rate and income, the amount of funds in speculative balances is very small as people have already invested their speculative balances. So, an increase in the demand for money due to fiscal policy measure will only raise interest rate that will lower the investment demand negating the initial increase in demand.

Part 3) Specific fiscal policy tools that can be used to stimulate or stabilize the economy includes, changes in the level of government expenditure including capital formation and investment by the government, tax rate changes, and changes in the subsidy.

Part 4) Specific monetary policy tools that can be used to stimulate or stabilize the economy includes, change in the money supply, and change in the policy rates.

Part 5) Depending on the existing state of the economy, fiscal or monetary policy measures should be used. As explained above, when the economy is operating at low level of interest rate and income fiscal policy should be used to stimulate aggregate demand. On the other hand, when the economy is operating at high levels of interest rate and income, then monetary policy will have the greatest impact on stimulating aggregate demand.