Question

Explain the differences between Monetary Policy and Fiscal Policy? Which policy do you think is best at stabilizing the economy during a recession or continue GDP decline?

Answer 1

Monetary policy is about raising the rate of interest and controlling the money supply.
Fiscal policy includes the government adjusting tax rates and government spending levels to affect aggregate economic demand. The Central Bank could have 2 per cent inflation target. When they fear inflation is going to go above the inflation target because economic growth is too high, then interest rates will increase.
Higher interest rates raise borrowing costs, which decrease consumer spending which expenditure, resulting in lower aggregate demand and lower inflation. The Central Bank would cut interest rates if the economy goes into recession

Fiscal policy is carried out by the government and includes changing: level of government spending Levels of taxation In order to increase demand and economic growth, the government must reduce tax and increase spending (leading to a higher budget deficit) To reduce demand and reduce inflation, the government may increase tax rates and reduce spending (leading to a smaller budget deficit)

Expansionary fiscal policy raises the amount of aggregate demand, either through government spending raises or tax cuts. If an economy is in recession and performing below its potential GDP, expansionary fiscal policy is best suited. Contractionary fiscal policy reduces the amount of aggregate demand, either through government budget cuts or tax increases. Contractionary fiscal policy is ideally suited when an economy performs above its expected GDP.