Fiscal & Monetary Policies

Controlling macroeconomic issues;


Controlling Economy

  • Economy is controlled by 2 policies
    • Fiscal (by Government):Taxes and ¬†Expenditures
    • Monetary (by Central Bank): Money supply and Interest rate

Fiscal Policies

  • Government spending and Taxes are the main weapon to control the level of economic activities (by Keynesian school)
  • To increase the level of economic activity
    • Increase Government expenditure
    • Decrease taxes
  • In the equilibrium
    • Government Expenditure + Investment Expenditure = Taxes + Savings
    • Any variation of this will cause inflation or unemployment.

Trade-off in Keynesian Model

  • There is a trade-off between unemployment and inflation.
  • Stagflation: In late 60s an 70s, US experienced high inflation and high unemployment due to the high government expenditure, oil shock, and heavy international competition.
    • Keynesian model can only solve half of the problem (inflation or unemployment, not both)
  • Fixes: Monetarists suggests that the severe short-term recession with the high interest rates can fix the stagflation,

Monetary Policies

  • Investment behavior depends on interest rates.
    • Higher interest rates discourage investment
    • Low interest rates encourage investment
  • The central back (such as Federal Reserves in US) can influence investment by changing interest rates

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