![]() ![]() ![]() Add to that concerns that consumers may not respond in the intended way to fiscal stimulus (for example, they may save rather than spend a tax cut), and it is easy to understand why monetary policy is generally viewed as the first line of defense in stabilizing the economy during a downturn. However, it typically takes time to legislate tax and spending changes, and once such changes have become law, they are politically difficult to reverse. Fiscal policy-taxing and spending-is another, and governments have used it extensively during the recent global crisis. Monetary policy is not the only tool for managing aggregate demand for goods and services. ![]() Congress, the employment goal is formally recognized and placed on an equal footing with the inflation goal. And at the Fed, which has an explicit “dual mandate” from the U.S. Indeed, even central banks, like the ECB, that target only inflation would generally admit that they also pay attention to stabilizing output and keeping the economy near full employment. The monetary policymaker, then, must balance price and output objectives. Workers then use their increased income to buy more goods and services, further bidding up prices and wages and pushing generalized inflation upward-an outcome policymakers usually want to avoid. As an economy gets closer to producing at full capacity, increasing demand will put pressure on input costs, including wages. Such a countercyclical policy would lead to the desired expansion of output (and employment), but, because it entails an increase in the money supply, would also result in an increase in prices. Monetary policy is often that countercyclical tool of choice. In short, there is a decline in overall, or aggregate, demand to which government can respond with a policy that leans against the direction in which the economy is headed. In a recession, for example, consumers stop spending as much as they used to business production declines, leading firms to lay off workers and stop investing in new capacity and foreign appetite for the country’s exports may also fall. Federal Reserve (Fed) or the European Central Bank (ECB)-is a meaningful policy tool for achieving both inflation and growth objectives. This is why monetary policy-generally conducted by central banks such as the U.S. But in the short run, because prices and wages usually do not adjust immediately, changes in the money supply can affect the actual production of goods and services. Most economists would agree that in the long run, output-usually measured by gross domestic product (GDP)-is fixed, so any changes in the money supply only cause prices to change. But however it may appear, it generally boils down to adjusting the supply of money in the economy to achieve some combination of inflation and output stabilization. Monetary policy has lived under many guises. 5 min (1403 words) Read BACK T O BASICS COMPILATIONĬentral banks use tools such as interest rates to adjust the supply of money to keep the economy humming ![]()
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