Fiscal and Monetary Policy - Essay Example

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Fiscal and Monetary Policy

This paper is aimed at investigating and defining the best way through which Britain should tackle the present financial crisis. To achieve this objective, the IS/LM model will be employed to see how various policy measures affect the interest rate, national income and inflation rates.
Fiscal policy refers to a situation whereby the government restores equilibrium in the economy by making changes to taxes or government expenditure on public goods and services (Smullen & Hand 2005). When there is under-utilisation of capacity, the government can increase capacity utilisation by reducing taxes (that is through a reduction in tax rates or tax base) or by increasing spending on public goods and services as well as subsidising the production of certain goods and services (Smullen & Hand 2005; Visser 2004:43). Fiscal policy aimed at increasing money supply is referred to as easy fiscal policy (Smullen & Hand 2005). On the other hand, when there is over-utilisation of capacity, the government either increases taxes (through and increase in tax rates or tax bases) or reduces spending on public goods and services (Black 2002). It also reduces subsidies and transfer payments. This type of fiscal policy is referred to as tight fiscal policy (Black 2002). ...Show more

Summary

The goals of monetary policy are a low rate of inflation ("price stability") and a small gap between actual real GDP and potential real GDP (Farinha & Marques 2001). Inflation can be maintained at low levels by limiting the amount of money in circulation, that is, by sufficiently limiting the growth in the broad monetary aggregate over a long enough period…
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