Question

Describe what fiscal and monetary policy are, who conducts each of them, how changes are made, and drawbacks that each type of policy might have. What do you think the best policy option would be in a deep recession and why do you think that?

Answer 1

Fiscal Policy and who conducts it

Fiscal policies are the government policies regarding taxation and government expenditures. Fiscal policies are conducted by the government.

Monetary Policy and who conducts it

Monetary policies are the policies regarding money supply and interest rate. Monetary policies are conducted by the central bank of an economy.

How changes are made

In case of fiscal policy, the government changes the tax rates or the expenses.

In case of monetary policy, the central bank changes money supply and interest rates through changing the reserve requirements of banks, or the federal funds rate (the rate at which banks lend each other), or by printing more money, or through open market operations to buy or sell assets, or a combination of these policies.

Drawbacks

Fiscal or monetary policies may not always be appropriately timed to address the ongoign economic problems. Also, an expansionary fiscal policy might result in higher government deficits and other associated problems. Also, fiscal policy development involves ebates and consensus development within the government and with opposition parties. So, fiscal policy development and implementation is time-cnsuming.

Monetary policies may not be always effective to stimulate the economy, especially when the interest rate is already very low.

Best Policy Option in Deep Recession

In a deep recession, the output, income and employment level falls very low. Therefore, expansionary monetary and fiscal policy should be undertaken to bring the economy back to normal. In expansionary fiscal policy, the government reduces taxes, increases spending or do both. As a result, aggregate demand (AD) increases and firms increase production. Therefore, expansionary fiscal policy helps to bring the economy out of recession. In expansionary monetary policy, money supply is increased by lowering the interest rate or lowering resreve requirements. Increase in money supply increases demand as well as supply and brings the economy back to normalcy.