Monetary vs Fiscal Policy

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When considering the choice between monetary and fiscal policy, it’s important to note that each has its own set of advantages and limitations.

Advantages of Monetary Policy

  • Reduced Political Influence: Monetary policy, set by the central bank, reduces the potential for political influence. This is in contrast to fiscal policy, where politicians might be inclined to use measures such as interest rate cuts to stimulate the economy before an election.
  • Quicker Implementation: Monetary policy can be implemented swiftly, as interest rates can be adjusted on a monthly basis. In comparison, decisions regarding government spending may take more time to determine where the funds should be allocated.

Advantages of Fiscal Policy

  • Supply-Side Effects: Fiscal policy can potentially have more supply-side effects on the economy, but it may be perceived as less favorable for certain measures, such as raising taxes and lowering spending to reduce inflation.
  • Demand Creation in Recessions: During deep recessions, government spending can create the necessary demand in the economy to kick-start recovery, which may not be achieved through monetary policy alone.

Combined Approach and Long-Term Effects

A combination of aspects from both policies has been adopted by the US to address economic problems. While both policies have limited effects, fiscal policy tends to have a greater impact over the long run, whereas monetary policy often leads to short-term successes.

Changing Perspectives

Opinions on the management of the business cycle have evolved over time. While there was a previous consensus that activist fiscal policy should be avoided, this view has become more evenly disputed in recent years, reflecting changing perspectives within the economic community.