Fiscal and Monetary Interaction
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Fiscal and monetary authorities have similar goals. They are both concerned about fluctuations in output, unemployment, and inflation and use their respective tools to try and limit these fluctuations. There are ways in which they interact and ways in which they are different.
- Fiscal authorities have more to worry about than just economic fluctuations. They need to be aware of their deficit and debt levels while maintaining social programs (welfare), providing national defense, and reducing inequality.
- Monetary authorities are traditionally more concerned with inflation fluctuations (as opposed to output fluctuations) than fiscal authorities.
- Coordinating efforts to reduce fluctuations can lead to more efficient policy.
- The monetary and fiscal authorities could agree to work together in combating economic fluctuations. Coordination reduces interest rate and budgetary fluctuations.
- If the country is experiencing stagflation, the monetary authority could use its tools to try and bring down inflation while the fiscal authority uses its tools to bring down unemployment.
- Monetary and fiscal authorities can fight against each other.
- Assume the monetary and fiscal authorities have different ideas on what they want theinflation rate to be. The monetary authority may raise the interest rate to bring down inflation (which would also bring down output). At the same time, the fiscal authority could increase spending to offset the output effects of the monetary authority’s policy (while at the same time increasing inflation).