Fiscal and monetary policies can be used by governments to stabilize economies during recessions and booms. Fiscal policies include changing government spending and taxes, while monetary policies focus on interest rates, money supply, and credit availability. Both have benefits but also limitations. It can be difficult to accurately predict the effects of fiscal changes on consumption and investment. Meanwhile, monetary impacts depend on how responsive borrowing is to rates and how stable money demand is. Using both fiscal and monetary tools together can create a more effective policy mix than relying on either one alone.

1. DEMAND SIDE POLICIES

2. FISCAL POLICIES MONETARY POLICIES

3. 1. FISCAL POLICY 1.1 Fiscal Tools: Government Expenditure (G) Taxes (T) Government’s Fiscal Stance: Expansionary v/s Contractionary

4. 1.2 Purpose of Fiscal Policy To correct disequilibrium in the economy To reduce fluctuations during business cycles. Hence, fiscal policies are also called stabilisation policies.

5. Existing fiscal tools can act as automatic fiscal stabilisers. OR Government can adopt discretionary fiscal policies NOTE: Government Expenditure multiplier effect > Tax multiplier effect How do Fiscal Tools work?

6. 1.3 Effectiveness of Automatic Fiscal Stabilisers Main Benefit: It acts instantly Main Problems: It does not eliminate fluctuations High taxes offer stability but discourages workers and investors Adverse effect of high unemployment benefits

7. Main Problems Magnitude Timing 1.4 Effectiveness of Discretionary Fiscal Policies

8. Magnitude Problem Difficult to predict the effect of a change in G An increase in G by x% can lead to increase in injections by less than x%. Why? Difficult to predict the effect of a change in T An increase in T affects consumers’ ability to spend and save. Outcome depends on whether consumers expect this change to be temporary or permanent.

9. Difficult to predict the size of the multiplier The effect on consumption or savings will depend on future expectations. It is also difficult to predict the increase in investment through the accelerator. Random shocks Unpredictable events can undermine effectiveness of fiscal policy.

10. Timing Problem Time lags are involved with fiscal policies. Why?? Government takes time to recognise the problem. Government takes time to take the appropriate action. It takes time for the change in policy to take effect.

11. The multiplier effect takes time to happen. Consumption adjusts slowly to change in T Note: If these time lags are long then fiscal policies can destabilise the economy. Example??

12. Undesirable Effects of Discretionary Fiscal Policy Cost Inflation Distributive Justice Disincentive Effects

13. 2. MONETARY POLICY 2.1 Monetary Tools Interest Rates The Monetary Policy Committee sets the interest rate in UK. Rationing of Credit This tool is not used now

14. Growth of money supply Central Bank can influence the money supply through: Open Market Operations (OMO) Discount Rate Reserve Ratio

15. 2.2 Effectiveness of Monetary Policy A) Effectiveness of credit rationing Benefit: It can direct loans towards productive purposes. Problems: Banks may resist Dampens growth of banks SMEs can be adversely affected Open world financial market reduces effectiveness of domestic policies

16. B) Effectiveness of changing interest rates Benefit: No implementation time lag Problems arise if: Demand for Loans is fairly inelastic Money demand is unstable

17. C) Effectiveness of controlling money supply: OMO may not reduce liquidity. Why?? Increase in reserve ratio may not slow down credit creation process. Why?? Increase in discount rate may not affect amount of loans created. Why??

18. POLICY MIX If fiscal and monetary policies are used together, they are more likely to be successful.