Question

examining the effectiveness of countercyclical fiscal and monetary policy in a credit constrained and non credit constrained economy during a recession. which one would it benefit more and why ?
books or literature to read for further information please

Answer 1

Fiscal policy could be more successful than monetary policy in a deep recession and liquidity trap as the government may pay for new investment projects, directly generating employment – rather than relying on monetary policy to indirectly persuade business to invest.

The constraint on credit is defined as the inability of some households to borrow against future income, perhaps. Because lenders believe that they are unlikely to repay their loans.

Monetary policy means changing interest rates and influencing money supply.

The central bank may have a two per cent inflation target. If they feel that inflation is going to exceed the inflation target because economic growth is too fast, they will raise interest rates.

Higher interest rates increase cost of borrowing and reduce consumer and investment spending, leading to lower aggregate demand and lower inflation.

If the economy were to go into recession, the central bank would have lowered interest rates.

Fiscal policy involves changing government tax rates and levels of government spending to influence aggregate demand in the economy.

In a downturn, the government can decide to increase borrowing and spend more on infrastructure spending. The idea is that this increase in government spending creates an injection of money into the economy and helps create jobs. There may also be a multiplier effect where the initial injection into the economy results in a further round of higher spending. This increase in aggregate demand can help the economy get out of the recession.