There are two major ways for the government to influence the economy: via monetary or fiscal policy. Monetary policy is the central banks’ tool for managing the overall supply of money to control and stabilize the inflation rate and promote economic growth (Mathai). Fiscal policy includes the government’s economic decisions about spending and taxation to encourage sustainable development and reduce poverty (Horton & El-Ganainy). Both monetary and fiscal policies incorporate several tools that governments can use when they believe their involvement is necessary to control economic processes.
One should remember that excessive governmental involvement in the economy is not useful, and monetary and fiscal policies should be used appropriately. Monetary policy can be helpful during a recession when consumers’ spending and business production decrease – the overall or aggregate demand (Mathai). Nevertheless, it is ineffective in the case of a liquidity trap, when people prefer to hoard money rather than buy or invest even when interest rates are zero or very low (Amadeo). Fiscal policy is helpful during the large-scale economic crisis to support financial systems and vulnerable groups (Horton & El-Ganainy). However, the fiscal policy takes more time to adopt and is less flexible than monetary (Mathai). Moreover, fiscal policy would be inefficient and harmful in countries with high inflation and external current account deficits (Horton & El-Ganainy). Thus, it is necessary to assess many factors to choose a monetary or fiscal policy.
Both monetary and fiscal policies include several tools that can stimulate aggregate demand. For instance, investment in infrastructure is considered a very efficient fiscal tool for boosting the macroeconomy as it also increases private-sector investments (Bivens, 2017). It was also revealed that expansionary monetary policy tools, such as interest rates management, accommodated the positive effect of this fiscal intervention (Bivens, 2017). Therefore, sometimes it is necessary to use a combination of monetary and fiscal tools to boost aggregate demand.
To conclude, monetary and fiscal policies can be useful for stabilizing and stimulating the economy when they are used smartly and appropriately. Government and central banks should always assess the situation to decide whether their policy would help or lead to negative consequences. They should choose an appropriate monetary or fiscal tool, apply it at the right time, and change the policy when the current one is ineffective or no longer necessary. If they do so, I do not see why they should not use monetary and fiscal policy.
References
Amadeo, K. (n.d.). Liquidity trap with causes, signs, and cures. The Balance.
Horton, M., & El-Ganainy, A. (n.d.). Fiscal policy: Taking and giving away. International Monetary Fund. Web.
Mathai, K. (n.d.). Monetary policy: Stabilizing prices and output. International Monetary Fund.
Bivens, J. (2017). The potential macroeconomic benefits from increasing infrastructure investment. Economic Policy Institute.