Monetary & Fiscal Policy: Interactions & Effects

This assignment delves into the crucial relationship between monetary and fiscal policy. It examines how these two policy tools influence aggregate demand and the economy. Students analyze various theoretical frameworks, including New Keynesian economics, and consider the effectiveness of both policies in addressing economic challenges such as inflation and recessions. The assignment also explores the potential conflicts and coordination issues that can arise between monetary and fiscal authorities.

ECONOMICS FOR
BUSINESS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
Use of supply side policies to facilitate economic growth.....................................................1
TASK 2............................................................................................................................................4
Use of fiscal and monetary policy to encourage economic growth........................................4
CONCLUSION................................................................................................................................9
REFERENCES..............................................................................................................................10
ILLUSTRATION INDEX
Illustration 1: Fiscal Policy and Aggregate demand-supply curve..................................................6
Illustration 2: Impact of Monetary and fiscal policy on Aggregate demand...................................9

INTRODUCTION
Economics for business is the application of the economic theory and quantitative
methods in business for the increment of their productivity and efficiency. It identifies the
relationship between different associated factors such as labour, capital and product markets.
These methods are adopted for the optimum allocation of resources. On national level,
government and other organisation uses different tools to stabilize the economy. Few tools are
supply side policies, fiscal policy and monetary policy (Gertler and Karadi, 2011). Supply-side
policies are approach adopted by government to increase productivity in economy using certain
ways. Monetary policy is the tool adopted by central bank to regulate money supply and fiscal
policy is the tool to stabilize the economic condition of the country. Present report is prepared to
elucidate the three concepts and their utility for a country.
TASK 1
Use of supply side policies to facilitate economic growth
Meaning: Supply side policies are the methods adopted by the government to increase the
productivity of the economy through bringing changes in the factor of production. In this way it
is able to improve institutional framework and capacity to produce (Murfin, 2012). Further, with
the adoption of these methods it is able to shift the long run aggregate supply curve to the right.
Types: There are two ways in which government is able to increase the productivity of the
economy firstly through enforcing market forces and enhancing their impacts which is referred
as the market based policies and secondly the policies which required the intervention in
incrementing the quality and quantity of the factors of production is referred as the
Interventionist policy.
Objectives of supply side policies
Supply side policies are used by the government to fulfil certain objectives and goals and
targets for the economy.
Lowering of inflation: Global market volatility and economic crises brings changes in the price
level of the country in the significant manner. While such fluctuations, there are times when
price level consistently rise which is harmful for the health of the economy. In that condition,
government uses this supply side policies to bring down the price level and stabilize the
economy. It helps in reducing the cost push inflation existing in the country.
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Reducing unemployment: With the fluctuations and downturn in the economy, countries are
facing heavy crises due to which they are not able to employ the persons in their organisation.
Due to this and other factors comprising contribute to the increment of unemployment in the
economy. In that respect supply side economies are adopted by the countries to reduce different
forms of unemployment existing in the country through training and development and education.
With the adoption of this measure, country is able to reduce the unemployment rate in the
country in most efficient manner (Nakata, 2013).
Improve economic growth: Supply side policies are adopted to bring growth and development in
the economy in the better and systematic manner. There are different tools and methods adopted
by it to ensure the growth and development.
Improved trade and balance of payments: Government's fundamental aim to bring improvements
in the balance of payments condition of the country. In that regard different measures are
adopted as per the suitability. Methods such as privatisation, de-industrialisation and related
helps in improving the productivity of the companies and firms working in the industry. In this
way it derives the sustainable rate of growth and development through enhancing the exports and
reducing the imports in the country. Through the increment in the competition and productivity
growth and development is ensured as done in south east Asian countries.
Both the policy types work differently in order to derive the desired goals and tragets of
the economy.
Interventionist Policies
Government of the country take crucial steps in four sectors to escalate the growth that
are competition, labour market, labour force and infrastructure (Altig and et.al, 2011).
Competition: At present with the fast development and globalisation there has been increase in
the number of firms as well as change in market scenario. There is the increase in the trend of
single sided inclination of market condition. In that respect, government intervene through
imposing the strict competition policy to prevent the hegemony or monopoly power of any firm.
This step is undertaken to promote the growth and development of the small firms. This type of
policy is adopted by USA to making the norms and regulation strict (Technology does not harm
the workforce, should be embraced by humanity, 2016).
Labour Market: At present, different international organisations such as European union and
others are adopting the supply side policies in this section that is labour market. With the
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application of this policy, it enables the free or liberalised mobility of labour between different
countries for their improvement. Along with such organisation nations also promote labour
mobility through subsidizing the relocation of the workers (Davig and Leeper, 2011).
Labour Force: The countries rich in the human resource has the key focus on this type of policy.
In this way they are able to leverage the benefits of wide availability of labour in the country.
This process is referred as utilizing the human capital. Realising the impact on the aggregate
demand and aggregate supply, government focus on training and education of the human capital
in the country. In that respect in many countries the training of the employees and labour force is
subsidized for the companies. In this way, the quality and quantity of work is enhanced. Through
increasing the education and health care, government enables the country to lead towards the
higher productivity area.
Infrastructure: Infrastructure is the base of the growth of the economy. The efficiency of the
infrastructure escalated the rate of development and upliftment in different ways (Martin, 2011).
This is the necessary structures, which facilitates the economy to sustain and enhance the societal
living conditions. It includes the development of roads, bridges, tunnels, water supply, sewers,
electrical grids, telecommunications and other physical components of interrelated systems.
Government through making investments in these sections increases the efficiency and
productivity of the organisation.
Market Based Policies
Increasing incentives: In order to encourage the spending and investments, government reduce
the taxes laid on them. In this process, the companies are able to have profitability and growth
possibilities. In this process, government raises the incentives and subsidies to the small firms or
the companies in the sector which require growth.
Promote competition: In this process, government by selling its shares and bonds to the private
companies brings improvements and growth in efficiency (Werning, 2011). This process is
referred as the privatisation. On the other hand deregulation refers to the liberalising in the norms
and regulations laid by the government in different sectors.
Supply side policies
Privatisation: It is the process in which the government of the country sells its owned ventures
and firms to the private owners with the aim to enhance the efficiency and productivity. As the
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private companies are more oriented towards the enhancement of profitability and minimization
of cost incurred in the company.
Deregulation: There are many barriers in the growth and development of any company or
venture. One such is the imposition of regulations and laws imposed by the government. For
instance, companies such Du Pont chemical company and others faces hindrances in growth due
to wide range of laws (Mishkin, 2011). Hence, government through liberalising the regulations it
ensuring the growth of the country by encouraging the companies to grow. Also, the deregulation
policy has made the telecommunication industry to grow faster and effectively around the globe.
Reducing income taxes: IN this process government entourages the provision of incentives I the
company which enable them to work harder and increase their efficiency level. In this way the
productivity and capacity of the resources to generate revenue increases.
Increasing training and development: Supply side policies work with the fundamental aim to
increase the productivity (Greenlaw and et.al, 2013). And it can be increased by making the
labour force of the country more effective and efficient. It can be possible through proper
training and development process.
TASK 2
Use of fiscal and monetary policy to encourage economic growth
The two most effective tool used by the countries in order to stabilize the condition of the
economy and bring the growth and development are the fiscal and monetay policy.
Fiscal policy
Fiscal policy is tool adopted by the government to bring the stability in the economic
condition with the use of certain tools and elements. Fundamentally, government uses two
elements that spending and the taxation. Spending refers to the process of making expenditure in
the country in order to bring improvements in different aspects. On the other hand, taxation
refers to the increase in the taxes imposed on the various activities performed in the economy
with the aim to bring stability (Crucini, Kose and Otrok, 2011). With the use of fiscal policy,
government is able to regulate the condition with enhancing development. There are two types of
fiscal policy that are expansionary fiscal policy and the contraction fiscal policy.
Expansionary fiscal policy: The policy in which the government of the country increases the
expenditure in different sectors and bring improvements is referred as the expansionary fiscal
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policy. This type of fiscal policy is used at the time of the recession when there is very less
amount of money in the market and people have the very low disposable income to invest and
spend. At this time, the condition of the economy become stagnant and struggles for growth.
With the investment made by the Government, economy is able to revive and back to the
recovery period. These spending are done in different forms such as through granting subsidies,
investments on infrastructure and other required areas (Frankel, 2011).
Contraction fiscal policy: In this type of policy, the government of the country reduces the
expenditure and spending level. Further, on the other hand it increases the taxation to derive the
money from the economy. This type of policy is adopted by the government at the time of the
inflation. Inflation is the time when there is large amount of money in market and the purchasing
power of people is significantly high. It raises the price level that affects the growth and
development in the considerable manner. Hence, in order to stabilize the condition, government
imposes the contraction fiscal policy in which heavy taxes are levied on the wide range of items
and goods. In this way the money flow and circulation in the country is balanced that stabilize
the condition effectively.
Tools of fiscal policy and economic growth
There are fundamentally two tools used by the government in the fiscal policy such as
spending and the taxation. Spending refers to the process of making expenditures for the
bringing up of growth and development of the economy. Government making spending on the
basis of requirement and the condition prevailing (Charpe and et.al, 2011). For instance, in UK
which is the mixed capitalist economy where the industries in different sectors is growing with
the very fast pace government spends through granting subsidies. Further, it grants relaxation in
different ways to foster the growth of the small companies and organisation. Along with there are
areas which are experiencing the downturn and the crises on both the growth aspects and
financial grounds. Hence, through investments in training and development and other ways it is
processed.
Secondly, the taxation it refers to the process of levying duties and taxes on the import
and export, buying and selling of the products and services in the country. Government with the
existing position in the country such as the need of the revenue generation and the other aspects
of the profitability taxation is levied. Such as to improve the condition of balance of payments,
the imports are made expensive through levying heavy duties and taxes (Stein, 2011). On the
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other hand, relaxation in export taxes is made on the exports to encourage the international
selling of the products and services by the industries on the global platform by them.
The above figure states that expansionary and contraction fiscal policy brings changes in
the aggregate supply curve through changes in its slope. Further, the changes are seen in the
aggregate demand with their shifts.
Monetary policy
Along with the government of the country, there are many other legislative and other
bodies who is responsible to regulate the economic condition of the country. Hence, one such
organisation is the central bank who is entitled to take care about the money circulation in the
country. Money circulation is the important component of the economy due which all the
economic activities' comes in process. In this type of policy, central bank through adopting
different tools and technique balances the flow of money. The methods used by it are the interest
rate fluctuations, open market operations, buying and selling of the government securities,
changes in the bank rates and other related (Allen, Tainter and Hoekstra, 2012). There are two
types of monetary policy used in the countries that are expansionary policy and contraction
policy.
Expansionary monetary policy: It refers to the process in which the circulation of money is
increased through different ways. The situation when there is lack of money in the market and it
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Illustration 1: Fiscal Policy and Aggregate demand-supply curve
(Source: Borio and Zhu, 2012)

requires increasing the spending by the consumers. For such process, central bank decreases the
interest rates. Through this the loans and lending become easier. In this country are in position to
have large amount of money and is able to spend more (Arrow and Kruz, 2013). Expansionary
policy in the economy are required to be used with certain obligation to prevent to convert in the
inflationary condition.
Contraction monetary policy: It is the policy used to control the money flow in the market. The
situation when there is large amount of circulation of money in the market, central bank adopts
measures to control and regulate it in the effective manner. For the purpose it adopts the
measures such as increase in interest rates. It makes the loans and renting difficult and expensive.
This type of policy is adopted at the time of inflation where the price level and people's
purchasing power are high. For instance, the higher interest rates induces the saving and reduces
the investments made by people. With this the prices of assets lower down and the stock market
balances.
Tools of monetary policies and economic growth
There are some tools used by the central bank to implement the monetary policy in the
country such as interest rates, bank rates, open market operations and reserve requirements.
Interest rates: It is the fundamental tool used by the central bank to ensure the growth and
development of the country through using monetary policy. Interest rates are tools which ensure
the money circulation and determines the flow of money (Galí, 2015). Changes in interest rates
are used by the central bank to increase growth. For instance, analysing the global trend, United
Kingdom has kept the interest rates stagnant with the expectation of bringing growth and
development. Nation has used it to keep the country insulated from the external shocks such as
the stock market fluctuations in china, plunging oil prices and other related. Hence, by keeping it
low United Kingdom has revived the economic growth since 2008 in the significant manner and
entered into the phase of recovery.
Bank rates: The rates on which the commercial banks borrow money from the central bank and
vice versa are referred as the bank rates (Gertler and Karadi, 2011). The terminology used in
every country is different such as in Asian nations like India it is used as bank rates on the other
hand in countries like United Kingdom it is referred as base rate. The changes are made with the
fundamental aim to changes the process of property and assets and money circulation in the
economy. For instance, when the country is facing the recession the money supply is low hence
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the central bank raise the bank rates to make the loans expensive. In this way, the spending is
being regulated through higher bank rates and savings are encouraged. On the other hand, the
condition when the country is facing the condition of high money circulation the bank rates are
lowered.
Open market operations: It is the process in which central bank of the country buys and sells the
government securities kept at it. In the situation when there is high money circulation, central
bank sells the government securities and bonds, in this way the money is derived from the
economy and kept to the central bank again (Lenza, Pill and Reichlin, 2010). This step is
undertaken by the country with interaction from public. On the other hand, the opposite measures
are adopted at the time of requirement of high money supply that is purchasing of the
government securities from the market. In this, it is able to increase the flow of money in the
market. This is the lucrative method adopted by the countries to bring growth and development
(Mahadeva and Sterne, 2012).
Reserve requirements: it refers to the process of making changes in the reserve kept at the
commercial bank for the requirement of the customers. With the changes in this tool, central
bank is able to make changes in money circulation. Hence, the growth is ensured in this manner
more effectively.
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From the above figure it can be concluded that the changes made in interest rates and
government purchases has the direct influence on the aggregate demand.
CONCLUSION
In the above study, an analysis is made about the use of supply side policies, monetary
policies and fiscal policies by the economy to stabilize the condition (Safarzyńska and van den
Bergh, 2010). From the report, it has been articulated that countries adopts the policy on the
basis of the situations prevailing there. Such as UK using low interest monetary policy, India
using supplies side policies to bring growth and development through making investments in
technology and infrastructure.
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Illustration 2: Impact of Monetary and fiscal
policy on Aggregate demand
(Source: Murfin, 2012)

REFERENCES
Books and Journals
Allen, T.F., Tainter, J.A. and Hoekstra, T.W., 2012. Supply-side sustainability. Columbia
University Press.
Altig, D. and et.al., 2011. Firm-specific capital, nominal rigidities and the business cycle. Review
of Economic Dynamics. 14(2). pp.225-247.
Arrow, K.J. and Kruz, M., 2013. Public investment, the rate of return, and optimal fiscal policy
(Vol. 1). Routledge.
Borio, C. and Zhu, H., 2012. Capital regulation, risk-taking and monetary policy: a missing link
in the transmission mechanism?. Journal of Financial Stability. 8(4). pp.236-251.
Charpe, M. and et.al., 2011. Stabilizing an unstable economy: Fiscal and monetary policy,
stocks, and the term structure of interest rates. Economic Modelling. 28(5). pp.2129-
2136.
Crucini, M.J., Kose, M.A. and Otrok, C., 2011. What are the driving forces of international
business cycles?. Review of Economic Dynamics. 14(1). pp.156-175.
Davig, T. and Leeper, E.M., 2011. Monetary–fiscal policy interactions and fiscal stimulus.
European Economic Review. 55(2). pp.211-227.
Frankel, J.A., 2011. How Can Commodity Exporters Make Fiscal and Monetary Policy Less
Procyclical?.
Galí, J., 2015. Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New
Keynesian Framework and Its Applications. Princeton University Press.
Gertler, M. and Karadi, P., 2011. A model of unconventional monetary policy. Journal of
monetary Economics. 58(1). pp.17-34.
Greenlaw, D. and et.al., 2013. Crunch time: Fiscal crises and the role of monetary policy (No.
w19297). National Bureau of Economic Research.
Lenza, M., Pill, H. and Reichlin, L., 2010. Monetary policy in exceptional times. Economic
Policy. 25(62). pp.295-339.
Mahadeva, L. and Sterne, G. eds., 2012. Monetary policy frameworks in a global context.
Routledge.
Martin, F.M., 2011. On the joint determination of fiscal and monetary policy. Journal of
Monetary Economics. 58(2). pp.132-145.
Mishkin, F.S., 2011. Monetary policy strategy: lessons from the crisis (No. w16755). National
Bureau of Economic Research.
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Murfin, J., 2012. The Supply‐Side Determinants of Loan Contract Strictness. The Journal of
Finance. 67(5). pp.1565-1601.
Nakata, T., 2013. Optimal fiscal and monetary policy with occasionally binding zero bound
constraints.
Safarzyńska, K. and van den Bergh, J.C., 2010. Demand-supply coevolution with multiple
increasing returns: Policy analysis for unlocking and system transitions. Technological
Forecasting and Social Change. 77(2). pp.297-317.
Stein, J.C., 2011. Monetary policy as financial-stability regulation (No. w16883). National
Bureau of Economic Research.
Werning, I., 2011. Managing a liquidity trap: Monetary and fiscal policy (No. w17344).
National Bureau of Economic Research.
Online
Technology does not harm the workforce, should be embraced by humanity. 2016. [Online].
Available through:<http://www.thedaonline.com/opinion/article_24c2cf58-0b67-11e6-
bf93-c33c736c3177.html>. [Accessed on 26th April 2016].
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