Answer to Question #45130 in Macroeconomics for Yiorgios

Question

Explain in theory how Fiscal and Monetary policy can complement each other to achieve domestic economic stability. Analyse how and whether fiscal and monetary policy settings over the past two years may provide for the achievement of domestic stability.

Answer 1

In most countries, inflation may be caused by a combination of factors, which may necessitate a comprehensive macroeconomic package to address the inflation problem. Indeed, monetary policy alone, no matter how sound and prudent, cannot do the job of short-term stabilization and the promotion of stable long-term price development in such an environment. It would also need to be complemented with fiscal policy restraint as well as measures to alleviate supply constraints. As such, monetary and fiscal measures need to complement each other; the former could be geared principally to managing liquidity in the economy, while the latter could focus on fiscal consolidation. Other supply-side measures could be instituted to complement macroeconomic policies while other measures including the promotion of savings are important as part of the drive to control inflation in the economy. Of special importance is the proper co-ordination of these policies, as well as the commitment to price stability by all levels of the government. In addition, the private sector needs to be aware of their role to combat inflation and increase savings.