Economics Essay: Fiscal and Monetary Policy in Secular Stagnation

This essay examines the effectiveness of fiscal and monetary policies in achieving economic stability, particularly in the context of secular stagnation. It begins by contrasting the traditional advantages of monetary policy, such as political neutrality and avoidance of government debt burden, with fiscal policy. The essay then argues that in an environment of secular stagnation, where economic growth is negligible, fiscal policy becomes a more potent tool. It explains how government borrowing and investment can absorb excess savings and stimulate demand. The essay highlights the current global threat of secular stagnation, which can trigger a vicious cycle of slow economic growth in both industrialized and emerging market economies. The conclusion reinforces the idea that while monetary policy is generally preferred, fiscal policy is more effective during secular stagnation and that the world economy is facing an increasing risk of it.

Running head: ECONOMICS
Economics
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1ECONOMICS
Introduction
The two prudent macroeconomic policies used for ensuring economic stability are fiscal and
monetary policy. The essay evaluates effectiveness of the two policy measures in attaining the goals of
stable economy. In this context, particular focus has been given on role of the two policies in the
environment of secular stagnation.
Fiscal vs Monetary policy for economic stability
Under traditional circumstances monetary policy is preferred over fiscal policy because of some
obvious advantages. The first argument in favor of monetary policy is that monetary authorities of a
nation are politically neutral. The central bank which designs the monetary policy is free from state
governance for all intents and purposes. This helps to achieve the objective of high employment and
stability in price level in an unbiased designing of policy unlike the fiscal one reflecting bias decision of
acting political parties (Kirchner and Sweder). Another advantage of monetary policy over the fiscal one
is that the latter does not impose a debt burden on the government. The expansionary fiscal policy has an
obvious tendency to overspend resulting in a budget deficit. Fiscal policy also has other detrimental effect
on the economy (crowd out private investment) that monetary policy is free from.
Secular stagnation and fiscal policy
Secular stagnation refers to an economic state of negligible or no growth in a market-oriented
economy. In an environment of secular stagnation, the impact of fiscal policy is much greater than that of
monetary policy (Summers). Secular stagnation in an economy occurs because of a change in demand and
supply of savings. The fiscal policy stimulus by rising government budget deficit raise interest rate in the
economy. This in turn counteracts the situation of secular stagnation by raising the tendency of saving and
increasing demand for loans. In such a model, government debt absorbs excess saving in the economy.
Government thus acts as a borrower of last resort as like central banks role of “lender of last resort”. It is
thus preferable to rely on fiscal policy stimulus as a response to the problem of secular stagnation as
government borrowing and investment seems to be more attractive in world having projects with a high
return (Summers).
Problem of secular stagnation in world
The world economy today is facing the danger of a most severe problem known as ‘secular
stagnation’. This refers to the inability of industrialist world to ensure a satisfactory economic growth
with a very ease monetary policy. The problem is getting worse in the awake of this problem in one of the
biggest emerging market economies like China (washingtonpost.com). The problem of secular stagnation

2ECONOMICS
increases the spectrum of global vicious cycle where slow economic growth of the industrial countries
hurts the economic growth of emerging market economies. This further leads to a growth slowdown in
western economies. The world economy thus is likely face a global shock arising from secular stagnation.
Conclusion
The discussion so far made suggest that traditionally though monetary policy is preferred over
fiscal one however in an environment of secular stagnation fiscal policy is a more effective tool. Finally,
the world economy today is facing an increasing risk of secular stagnation resulting in a vicious cycle of
growth slowdown.

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References
Kirchner, Markus, and Sweder van Wijnbergen. "Fiscal deficits, financial fragility, and the effectiveness
of government policies." Journal of Monetary Economics 80 (2016): 51-68.
Summers, Larry. "Responding To Some Of The Critiques Of Our Paper On Secular Stagnation And
Fiscal Policy | Larry Summers." Larrysummers.com. N.p., 2019. Web. 2 Apr. 2019.
Summers, Lukasz. "On Falling Neutral Real Rates, Fiscal Policy, And The Risk Of Secular
Stagnation." Brookings. N.p., 2019. Web. 2 Apr. 2019.
washingtonpost.com. "The Global Economy Is In Serious Danger." The Washington Post. N.p., 2019.
Web. 2 Apr. 2019.