Do macroeconomic policies conflict?

Fiscal and supply-side policy
Increased government spending may be used as part of a fiscal policy to increase aggregate demand, and much of this spending will be directed towards the health and education sectors. In this case, fiscal and monetary polices are working in tandem to improve growth prospects, and the supply-side effects may cancel out any ill effects on the price level from the expansion in demand.

By contrast, if a government is using contractionary fiscal policy as a means of trying to control the price level, the impact may be a leftward shift in the AS curve, and therefore prices may rise rather than fall and output might contract even further than intended.

Fiscal and monetary policy
While these are both demand-side policies, if a government runs a budget deficit, this has to be financed which will affect the money markets. Much of the budget deficit is financed by issuing 3-month treasury bills, which offer investors secure and liquid assets which are easy to trade on the money markets. This helps with stability during a credit crunch, but at other times it might be inflationary as it increased liquidity available. A looser fiscal policy can mean that the MPC favours a tighter monetary policy, taking into account the fiscal stance in deciding whether to change interest rates.

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2 thoughts on “Do macroeconomic policies conflict?

  1. I think your last point about monetary policy and supply side policies is wrong.
    “Furthermore, raising interest rates tends to make exchange rates rise. As UK firms import nearly all of their raw materials, the effect on production costs may be significant. Therefore tight monetary policy can worsen the supply side, although higher exchange rates are not guaranteed, and they do help firms to export.”

    An increase in the interest rate, leads to an appreciation in the currency. This makes imports cheaper, thus having a positive effect on firm which import raw materials. However, it has a negative effect on exporters. Therefore tighter monetary policy, will not help exporters due to the appreciating exchange rate.

    “By contrast, cutting interest rates in monetary policy can reduce import costs for domestic firms, but if the exchange rate falls then firms will loose their international competitiveness.”

    Cutting interest rates will INCREASE import costs due to a depreciating currency, but the exports will become more competitive.

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