Stabilizing the Economy

1 Stabilizing the Economy The government is responsible for managing and stabilizing the economy to ensure that there is a stable level of money in the economy. The government control economic activity through two approaches; fiscal policy and monetary policy. Fiscal policy involves influencing taxation rates and people’s spending capacity. It may also be used to redistribute wealth and income such that the poor are taxed less in order to increase their spending capacity and standard of living, while the wealthy are taxed more in order to reallocate their wealth. On the other hand, monetary policy involves controlling the level of money supply within the economy as well as the interest rates. The policy that the government will apply depends on the prevailing economic conditions. Fiscal and monetary can be used together to accelerate economic growth, or to slow it down when the economy begins to grow too fast.

There are periods where applying monetary or fiscal policies may have a negative impact on the economy. For instance, implementing the fiscal policy of increasing tax rates when people’s economic burden is already high due to factors such as inflation and high interest rates is inappropriate and detrimental to the state of the economy. Likewise, monetary policy should not be relied upon in isolation to generate meaningful economic growth.

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Aggregate demand can be stimulated through the use of expansionary fiscal policy tools such as reducing the tax rate and increasing government spending. Monetary policy can be used to increase aggregate demand increasing the money supply, which causes interest rates to decline. The drop in interest rates leads to higher investment spending which ultimately leads to a higher rate of aggregate demand. To ensure maximum stability of the economy, policymakers should use the right mix of fiscal and monetary policies. None should be used in complete isolation in the process of controlling the economy.

3 Reference Langdana, F.K. (2013). Macroeconomic Policy: Demystifying Monetary and Fiscal Policy.

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