Monetary and Fiscal Policies

Lesson

This section will explore the monetary and fiscal policies governments, and central banks use to manage the economy. Monetary policy involves the management of money supply and interest rates, while fiscal policy involves government spending and taxation. Both policies aim to achieve economic stability, growth, and full employment.

Practice Question #1

Which of the following is an example of expansionary monetary policy?

Terms

Monetary policy:

The process by which a central bank controls the money supply and interest rates to achieve economic stability and growth.

Fiscal policy:

The use of government spending and taxation to influence the economy.

Central bank:

An institution responsible for managing a country's monetary policy and regulating its financial system.

Interest rates:

The cost of borrowing money, expressed as a percentage of the principal amount.

Money supply:

The total amount of money available in an economy at a given time.

Inflation:

A sustained increase in the general price level of goods and services in an economy over a period of time.

Deflation:

A sustained decrease in the general price level of goods and services in an economy over a period of time.

Expansionary policy:

A policy aimed at increasing economic growth and employment by increasing the money supply or government spending.

Contractionary policy:

A policy aimed at reducing inflation by decreasing the money supply or government spending.

Full employment:

A situation in which everyone who wants to work can find a job at the prevailing wage rate.

Practice Question #2

Which of the following is a primary goal of both monetary and fiscal policies?

Do Not Confuse With

Supply-side economics:

A theory that focuses on increasing the supply of goods and services to stimulate economic growth rather than concentrating on demand-side policies like monetary and fiscal policies.

Keynesian economics:

A theory that emphasizes the importance of aggregate demand and government intervention in managing the economy, including monetary and fiscal policies.

Practice Question #3

Which institution is responsible for implementing monetary policy in a country?

Historical Example

In the early 1980s, the United States faced high inflation and unemployment. As a result, under Chairman Paul Volcker, the Federal Reserve implemented a tight monetary policy by raising interest rates to combat inflation. This policy eventually led to a recession but successfully reduced inflation and laid the foundation for economic growth in the following years.

Real-World Example

In response to the COVID-19 pandemic, central banks worldwide implemented expansionary monetary policies by lowering interest rates and increasing the money supply. In addition, governments also implemented fiscal stimulus packages to support businesses and individuals affected by the pandemic.

Rhyme

Monetary and fiscal, two policies essential, For managing economies, their impact is substantial. Interest rates and money, the central bank's domain, While spending and taxation, the government's terrain.