Monetary and Fiscal Policy - Assignment

Added on - 16 Sep 2019

Analysis of Monetary and Fiscal Policy

This report is on "analysis of monetary and fiscal policy". The aim of this report is to determine the short-run effects on the various aspects of the economy when the confidence of the consumer falls, the effects of the policy mix on the interest rate, consumption, investment, the real exchange rate, the budget, and trade balances and to determine the impact of the policies in the European countries that are affected by the liquidity trap. Short-run effects of a fall in consumer confidence on the interest rate, consumption, investment, the real exchange rate, and net exports due to the consumer confidence has declined in the economy, and as a result of that, the total demand has also decreased.

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[TYPE THE COMPANY NAME]Analysis of Monetary andFiscal Policy using theopen economy IS/LMmodel for EuropeanCountriesModule:ABC[Pick the date]

IntroductionAn open economy is that economy where there is free flow of goods and services. The countrieshave the option to trade with the foreign countries and the international community can becontacted in any circumstances. Also, there is free flow of funds and investments acrosscountries in the open economy. The aim of this report is to determine the short run effects on thevarious aspects of economy when the confidence of the consumer falls, the effects of the policymix on the interest rate, consumption, investment, the real exchange rate, the budget and tradebalances and to determine the impact of the policies in the European countries that are affectedby the liquidity trap.Short-run effects of a fall in consumer confidence on the interest rate, consumption,investment, the real exchange rate and net exportsDue to the consumer confidence has declined in the economy, and as a result of that, the totaldemand has also decreased. This will lead to fall in the equilibrium output because with the fallin demand, the overall spending of the people in the economy falls, the rate of interest also falls(Kapetanios, 2012). Then, the consumption declines which makes the exchange rate and netexports declines too. This can be explained with the following diagram.1

In the above diagram, the graph 1 shows that the economy was at point A when the consumerconfidence did not decline. At point a, the output produced was Y1 and the rate of interest wasi1. But, with the fall in consumer confidence, the total demand declined and shifted the IS curveto the left i.e. IS shifted to IS’. With the fall in demand, the investment and the savings of peoplefall, so this affects the IS curve. Due to less demand, there is less output produced and Y shifts toY’. Also, the rate of interest has fallen from ‘I’ to ‘I’’.In the second graph, the exchange rate is determined the demand and supply of currency in theeconomy. With the interaction of demand and supply at point c, the exchange rate is set at ‘r’ andthe quantity is Q1. When the demand falls, the people use less of the currency and the demand ofcurrency falls. This makes the rate of exchange fall from r to r’.2

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Short-run Effects on the Economy

From the above report "short-run effects on the economy", we conclude that when the confidence of consumers falls, there is a decrease in the output of the economy, the rate of interest, exchange rate, investment, and net exports fall too. For recovering the economy from recession, a mix of monetary and fiscal policy is required and expansionary policies are used for helping the economy is recovering. With the policy mix, the rate of interest rises, the exchange rate improves and the economy starts to boom. But, a liquidity trap is one situation that is capable of making the monetary policies ineffective in the economy. When the economies fall into a liquidity trap as it happened in the case of European countries, the monetary policy gets failed and it no longer becomes effective.