Essay on Monetary and Fiscal Policy

2 pages
525 words
Harvey Mudd College
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Monetary and fiscal policy originates from the central bank and the national government respectively as there centers of power. The change of these aspects sporadically trigger the prevailing conditions of the economy. Specifically, the policies directly determine the consumption, spending, and the levels of investment in the economy. Therefore, fiscal policy uses the mechanism of tax rates and government spending to influence the aggregate demand. Taxes and government spending dictate the employment rate hence per-capita income which determines the consumption and investment level in the economy (Difference between monetary and fiscal | Economics Help, n.d.). On the other hand, monetary policy dictates the amount of money supply in the economy which influences inflation and interest rates, employment, the ratio of consumption versus saving, and net export.

The contractionary fiscal policy exists to avert rapid inflation by reducing government spending to control the growth of the economy whereas expansionary monetary policy conjures consumers to perceive consumption as more attractive by sugar-coating customers through decreasing the prices of commodities (How Do Fiscal and Monetary Policies Affect Aggregate Demand? | Investopedia,n.d.). Therefore, contractionary monetary policy comes to play to normalize the effects that come as a result of applying expansionary policy. Limiting money supply means there will be a slow expansion of businesses and low rate of consumption will affect the exporters hence reducing the aggregate demand.

Fiscal and monetary policies fight to create an equilibrium in the economy by balancing a weighing scale through preventing the decrease of aggregate demand by checking on employment rates to stabilize the level.

Unemployment and inflation are two mechanisms that operate on an inverse rule. When unemployment increases inflation reduces and vice versa (How Do Fiscal and Monetary Policies Affect Aggregate Demand? | Investopedia,n.d.). According to my opinion, maybe using historical data could help calculate the rate of unemployment using the existing rates of inflation. By doing that, a trade-off will be established without adversely affecting the economy. Therefore, as economic growth is realized, the rate of employment will be adjusted to suit the demands of the economy. If there is inflation, there is need I increase the inflation rates. The high-interest rates will reduce spending and investment consequently reducing aggregate demand.

In rare cases, we have observed a falling inflation with falling employment. For example, in the 1990s, the U.S experienced this scenario-inflation stayed low as unemployment was decreasing. This suggests that sometimes a fall in unemployment might have a little effect on inflation. However, if monetary policy is favorable, the economy can adjust to bust cycles that were experienced in the past and maintained a low inflammatory growth which reduces unemployment. In 2015, the inflation rate reduced from 5% to -2% this increased employment from approximately 5% to over 10%.


Difference between monetary and fiscal | Economics Help. (n.d.). Retrieved from

How can a change in fiscal policy have a multiplier effect on the economy? | Investopedia. (n.d.). Retrieved from change-fiscal-policy-have-multiplier-effect-economy.asp

How Do Fiscal and Monetary Policies Affect Aggregate Demand? | Investopedia. (n.d.). Retrieved from


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