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Pros and Cons of Fiscal Policy vs.

Monetary Policy
by Marjolein van der Veen

Fiscal Policy
Pros
If use Government spending, can direct
spending towards areas in need (e.g.
infrastructure, education, etc.), and make
investments for the future.
Using a balanced budget can provide a
stimulus without adding to the government
budget deficit.
While fiscal policy may lead to government
deficits/debt, we should look at debt/GDP
ratio. As only as GDP grows, it can bring
down the debt/GDP ratio.
Can use green taxes to discourage polluting
activities.

Cons
Knowledge problems (regarding the current
state of the economy; regarding the amount of
an expansion or contraction needed, etc.)
Government budget deficits (though theres
disagreement regarding the extent to which
deficits are a problem)
Time lags (particularly on the front end of the
process)

Some crowding out (extent depends on how


close the economy is to full employment)
Tax rebates may be spent on imports, thus
leaking out of the circular flow.
Actions of state and local governments may
counteract the federal fiscal stimulus (or
contraction).
Growing the GDP to bring down the
debt/GDP ratio can compromise
environmental sustainability.
What if we have stagnation + inflation? Could
exacerbate inflation

Monetary Policy
Pros
Can be initiated immediately

No government budget deficits


Expansionary policy leading to depreciating
currency can stimulate exports (at least for
businesses that do not rely on importing their
inputs).
The Fed is theoretically insulated from the
political process

Cons
Knowledge problems (regarding the current
state of the economy; regarding the amount of
an expansion or contraction needed, etc.)
Time lags (particularly response lags)
Cant direct the spending (to particular uses,
e.g. infrastructure), and spending may be done
in wasteful ways, e.g. speculation, mergers
and acquisitions.
Very low interest rates can foster speculative
activities (such as Japans yen carry trade.)
Feds change in interest rate is applied
nationally some areas in the country might
not need the stimulus, while states with high
unemployment might need the stimulus.
Reluctant lenders (Banks may be unwilling to
lend, especially if overwhelmed by bad loans
on the books)
Reluctant borrowers (pushing on a string)
(Firms may be reluctant to borrow, especially
if expectations of future sales and profits are
low.)
Limit of r=0%, liquidity trap
While government doesnt incur debt, the
private sector is encouraged to borrow and
take on debt.
What if we have stagnation + inflation? Could
exacerbate inflation