Fiscal Monetary Policies Essay

1995 Words Jun 20th, 2016 8 Pages
Question 1
Introduction

In economics there are two main schools of thought; these schools differ in their belief of what policies are best suited to attain full employment in the economy. Keynesians tend to favour demand side policies and are more prone to intervene in the market and therefore prefer to use fiscal policy whilst monetarists believe adjustments in money supply is more appropriate in stabilising the market ,therefore preferring monetary policy. In this question I will discuss the views of Keynesians and monetarists regarding the effectiveness of monetary and fiscal policies in controlling aggregate demand through the IS-LM framework. I will first provide a brief description of the curves explaining their formation and
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Keynesians say it is a mistake to wait for markets to clear like classical economic theory suggests. See more at Keynesian economics
Monetarism emphasis’s the importance of controlling the money supply to control inflation. Monetarists are generally critical of expansionary fiscal policy arguing that it will cause just inflation or crowding out and therefore not help.
Principles of Keynesianism * In a recession / liquidity trap, government intervention can stimulate aggregate demand and real output through government borrowing and higher government spending. Therefore Keynesians advocate expansionary fiscal policy in a recession. * Keynesians reject the theory of crowding out presented by Monetarists. Keynesians say that if there is a sharp rise in private sector borrowing, government spending can offset this decline in spending. * Paradox of thrift. A key element in Keynesian theory is the idea of a ‘glut’ in savings. Keynes argued in a recession, people responded to the threat of unemployment by increasing saving and reducing their spending. This was a rational choice, but it contributes to an even bigger decline in AD and GDP. * Keynesians usually believe there is a degree of wage rigidity. In a recession, Keynes said wages may be ‘sticky downward’ as unions resist nominal wage cuts, this can lead to real wage unemployment. Also, in a recession, when an economy has spare capacity, increasing Aggregate demand will have an impact on real output and

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