Monetary and fiscal policy are government attempts to smooth the business cycle,

Question

Monetary and fiscal policy are government attempts to smooth the business cycle, especially the use of expansionary policies to return to GDP growth from a recession. The goals are relatively short-term, not more than 5 years. Long-term growth, however, is arguably more important.

a) Should the national government ensure income equality through taxation and wealth redistribution?

b) According to Monetarists, what is the long-term result of continuing expansionary monetary policy in which the money supply grows faster than RGDP? Briefly explain using the EOE.

Explanation / Answer

a) The government should not ensure income equality through taxation and wealth distribution in such a case, rather it should focus on the expansionary monetary policy i.e. to increase the money supply

b) According to monetarists, if the governmet will continue using expansionary monetary policy then it can do this through open market operation which will change the interest rates and economic growth. But there is time lag of atleast 6 months to a year for this change of money supply on the economic growth as in the short run, the interest rates will decrease and correspondingly the investments will increase which will in turn increase the aggregate demand and the RGDP and thus the economy will start moving out of the situation of the recession. However, it takes a while for changes in interest rates to work their way through the economy. Due to the lag present between a change in monetary policy and a change in actual economic conditions the national governemtn will have to wait before policy changes have the desired effect of accelerating the economic growth.

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