IB HL Economics (Macroeconomic Policies) sample essay
Deflationary fiscal policies and tight monetary policies will often be used in conjucture during times in which inflation is on the rise (perhaps a little too much), and when which the government aims to apply deflationary pressure to ensure that inflation does not rise too much.
Deflationary fiscal policy is when government expenditure decreases and taxation increases. tight monetary policy is when the suppy of money is decreased and the interest rates are increased.
Decreasing government expenditure will have the effect of limiting the amount of facilitation the government provides to society to consume/invest, pressuring society to decrease society’s consumption/investment/expenditure. likewise, low supply of money as well as high interest rates will apply a brake on firms and consumers expenditure as they now incur a higher opportunity cost in consuming/supplying/investing due to increased interest rates.
Inflationary fiscal policy and loose monetary policy however, have the opposite effect on the economy, and this is because they are implemented at times when there is deflationary pressure on the price level (deflation). inflationary fiscal policy will increase government expenditure as well as decrease taxation, and loose monetary policy will increase the supply ofmoney as well as decrease interest rates.
By increasing government expenditure you can now subsidise goods, lowering costs which will have the effect of increasing consumption, as well as provide training schemes to help those who are unemployed find a job. increasing the supply of money increase the amount of flow of money in the economy as there has been an increase in the liquidity in cash. low interest rates attract firms as well as consumers as the opportunity costs to invest/consume have been decreased. for instance, if car loans were previously at 7% during times of inflation (and the government implemented a tight monetary policy), but via deflationary pressure and central banks implementing a decrease in interest rates the car loan interest rate goes down to 5%, it would be much more economical for you to buy a car when it was at 5% than 7% (increase consumption, which would lead to an increase in the price level as overall demand increases)
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