Compare the effectiveness of the fiscal and monetary policy with some reference to supply side policy in running the UK economy. Fiscal policy is used to change taxation and government spending in order to control the level

Economics Homework

**Compare the effectiveness of the fiscal and monetary policy with some reference to supply side policy in running the UK economy.

Fiscal policy is used to change taxation and government spending in order to control the level of aggregate demand, which can reflate or deflate the economy. Monetary policy is the control of money supply by changes in interest rates that affect bank lending, which then changes the level of AD.

Fiscal policy is far more effective than the monetary policy as it can target many things, whereas the monetary policy is limited on its effectiveness. Fiscal policy can be very effective when used at the right time, such as in a deep recession, because fiscal policy can cause a multiplier effect which can create jobs quickly and it gives people a boost in confidence, which then increases spending and investments. Monetary policy isn’t very effective when there is a recession, because even though it can create jobs but it still can’t attack investments and it can cause inflation to increase if we are too close to Nairu. It’s never ideal to just rely on just 1 policy, you have to use both together in order for the economy to run smoothly. If the fiscal policy is just used on its own then it may be overdone thus causing inflation to increase, these effects depend on whether or not we are close to Nairu.

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Too many injections from the fiscal policy will cause public spending to increase too much, which may then cause a consumer boom. This means there will be a shortage in the numbers of workers causing a rise in wages and prices. Fiscal expansion will make us buy more imports which is bad for the economy as this will damage our balance of payments, because if makes AD rise above AS causing inflation. When this happens fiscal policy will just continue to rise inflation, at a time like this both monetary and fiscal should be used at once. This is where monetary policy will be effective. Here monetary policy should be used to deflate the economy, which will slow down inflation and cause a drop in spending. Also by using monetary policy to cut interest rates, it will lower the pound causing our trade figures to improve significantly. Our trade figures improve because hot money leaves and the pound depreciates and causes exports to eventually rise and imports to fall which improves our current accounts, which is very good and effective in running the economy. The rise in exports will make more jobs available through the multiplier effect which in a long run should bring the economy back onto its feet.

SS policies are also very effective in curing a weak economy, because it improves all four objectives, whereas the fiscal and monetary policies can’t. SS policies cause competition to increase significantly, which then causes exports to improve and cuts inflation due to intense competition. Also it causes employment to rise and voluntary unemployment to fall, but the problem is this isn’t effective in a short run, it is only effective in a long run.

Fiscal and monetary policies can’t just be used by anyone, as it is not easy to control unless you really know what you are doing. For example weak governments and third world countries may not be able to control these policies and will let it out of control which will cause even more problems for that economy. Fiscal policy alone can cause a lot of damage unless prepared, if governments started spending as much as they could and pumped large injections into their economy then it will probably destabilise demand and will produce large business cycles just like we did from 1945-1995. The best thing to do is to make small changes to interest rates this way it will make gentle changes to the total money supply.

Monetary policy also requires a strong government who knows what they are doing, as it can be used at the wrong times. For example if a country was at full employment it might decide to devalue their economy, but this will cause severe problems of shortages and inflation. This is because the extra AD cannot create extra jobs or output due to the country being at full capacity, instead of expanding it will just increase inflation. The solution to this is to use supply side policies as it can reduce the natural rate of unemployment, allowing mild reflation through the fiscal and monetary policies, so it creates more jobs without causing inflation to increase.

Peer Reviews

Here's what a star student thought of this essay

groat

19th of Mar 2012

Quality of writing

The structure here is poor, as it skips out the analysis stage. The introduction is quite weak, as technically fiscal policy is the manipulation of taxation and government spending. I felt the language used here is colloquial at times, for example "fiscal and monetary policies canÃ¢â‚¬â„¢t just be used by anyone" doesn't sound sophisticated. This style doesn't come across as very convincing, detracting away from the essay's quality parts. Spelling, punctuation and grammar are fine.

Level of analysis

As mentioned above, there isn't enough analysis here, but there is plenty of good evaluation. I liked the awareness that fiscal policy is subject the multiplier, giving it a strong benefit. Sometimes the essay asserts things without being clear. For example they say "fiscal policy is far more effective than the monetary policy as it can target many things" yet it is not made clear that government spending is a direct component on aggregate demand. You must be clear what you mean, as an examiner cannot assume you have the understanding. Diagrams would have been useful in places, for example saying "SS policies are also very effective in curing a weak economy, because it improves all four objectives" seems unfounded without a diagram showing a shift in aggregate supply placing downwards pressure on the price level. I think there needed to be some discussion of examples of the policies. Supply side policy as a general term is used, but I would've looked at investment in education and training for example. This would've allowed evaluation, saying the time lag is substantial. But, to get top marks in this essay, there needed to be a discussion of "the effectiveness depends upon" as there isn't a clear cut answer for every situation. Such perceptive debate would've been strong.

Response to question

This essay engages with the effectiveness well, yet there isn't enough analysis. In my experience, to be rewarded for evaluative comments as this essay has done, you must have some analysis. This can be an explanation of how fiscal or monetary policies work, including a diagram. But, you are risking getting incredibly low marks if you don't build up an essay in response to this question. I would start by defining what the various policies are, then analysing how they work, then evaluating why different qualities will affect their effectiveness, coming to a justified judgement.

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