Question

Should monetary and fiscal policy be used to stablize the economy during periods of inflation and high unemployments? Describe one argument in favor and one against?

Answer 1

Monetary policy refers to the regulation of money supply and interest rates by the central bank. The advantage of regulating (decreasing) the interest rates is that a small amount of inflation is beneficial to the economy. It encourages investment. Similarly the central bank can control the inflation by increasing the interest rates.

However the disadvantage of decreasing the interest rates is that the inflation can go out of control and destroy the economy. Similarly increasing the interest rates can slow down the economy artificially which may lead to multiple problems that may move out of control.

Fiscal policy refers to the tax and spending policies of the government. A restrictive fiscal policy implies increase in the taxes and vice versa.

The main advantage of the fiscal policy is that the government can direct the spending to specific projects rather than impacting the entire economy. The major disadvantage of fiscal policy is that it can create a deficit in the economy due to high spending’s and low taxes.

The government should use both a combination of monetary and fiscal policies to maintain a healthy economy.