Question

Monetary and fiscal policy instruments are used to affect the aggregate demand (AD) in the economy.

What is the difference between contractionary and expansionary monetary policy? What is the difference between contractionary and expansionary fiscal policy? How does each policy affect the AD in the economy?

What are the benefits and major problems of the fiscal policy and monetary policy?

Answer 1

Answer : Monetary and fiscal policy are two important element to manage the economy of the country as whole. Monetary policy is controlled by centeral bank related to supply of the money circulation where as fiscal policy is controlled by federal government related to make changes in spending of the government or increase or decrease tax rates.

Contractionary monetary policy Vs Expansionary monetary policy :

• Contraction monetary policy is used by the centeral bank to decrease the supply of money where as expansionary monetary policy is used to increase supply of money for boosting the economy.
• When federal bank increases the money supply than they do the following such as purchase of securities , lower federal discount rate and lowe reserve requirement are the example of expansionary monetary policy where as in the case of contraction monetary policy there is selling of securities and vica-versa.
• Contraction monetary policy lead to decrease in the bond price and increasesinterest rates where as expansionary monetary policy lead to increase in bond price and reduce interest rate.
• In contraction monetary policy exchange rate has been rises where as expansionary monetary policy exchange rate has been decreased.
• Balance of trade decreases in contraction policy where as balance of trade increased in expansionary policy.

Contraction Fiscal policy VS Expansionary Fiscal policy :

• Contraction fiscal policy means when government decreases it spending or increasing taxes at the same time where as in expansionary fiscal policy means government increase spending and lower taxes.
• In Contraction fiscal policy lower amount of capital has been available for private businesswhere as expansionary fiscal policy more money has been invested in the business.
• In contraction it helps to control the growth of inflation where as in expansionary economic growth of the country.

AD ( Aggregate demand ) measures sum total demand of an economy.

AD =C+I+G+NX

Effect of fiscal policy on AD :

• Changes in government spending.
• Taxes has been changed
• It resulted change in household income as consumpation pattern has been changed.

Effect of monetary policy on AD :

• Business has been expanded or contracted which result change in investment.
• Net export has been affected.
• Employment and cost of debt has been affected
• Saving rate also changes.

FISCAL POLICY :

BENEFITS :

• Reduce unemployment rate as when unemployment rate is very high , government employed expansionary fiscal policy.
• Decrease in budget deficit.
• Boost the economy with expansionary monetary policy

COSTS :

• Conflict and disputes has been risen.
• Less flexibile

MONETARY POLICY :

BENEFITS :

• Chances of investment has been increases.
• Spending of the consumer has been increase
• Lower rate of home owners.
• Promoted low inflation rate
• Political freedom

COST :

• Not secured gurantee of recovery of an economy.
• Time consuming
• It is not useful at the time of recession.
• It could discourage business to expand