Fiscal and Monetary Policy Actions in the Short Run
| English | Chinese | Pinyin |
|---|---|---|
| Monetary policy | 货币政策 | huò bì zhèng cè |
| business cycle | 经济周期 | jīng jì zhōu qī |
| money market | 货币市场 | huò bì shì chǎng |
| investment | 投资 | tóu zī |
| Stabilization policy | 稳定政策 | wěn dìng zhèng cè |
| Full employment | 充分就业 | chōng fèn jiù yè |
| potential GDP | 潜在GDP | qián zài GDP |
| Price stability | 价格稳定 | jià gé wěn dìng |
Two hands on the same wheel
- The government steers aggregate demand with fiscal policy — spending and taxes.
- The central bank steers it with monetary policy — the money supply and interest rates.
- Both can push AD the same way, at the same time.
- Together they aim to smooth the business cycle.
The monetary chain
- Monetary policy 货币政策 works through the money market 货币市场: buying bonds raises the money supply and lowers the interest rate.
- A lower interest rate makes borrowing cheaper, so investment 投资 rises, lifting $C + I$.
- So AD shifts right — the same direction as expansionary fiscal policy.
- The chain: money supply ↑ → interest rate ↓ → investment ↑ → AD →.
The AD-AS model
Both fiscal and monetary policy shift AD. Combine expansionary versions and the rightward shifts add up, closing a recessionary gap faster.
Put the expansionary monetary chain in order.
More money lowers the rate, which lifts investment and shifts AD right.
Expansionary monetary policy shifts AD in the same direction as:
Both cut interest rates or taxes to raise spending, shifting AD right.
When the central bank buys bonds, the interest rate:
Buying bonds raises the money supply, lowering the equilibrium interest rate.
Two goals of stabilization
- Stabilization policy 稳定政策 smooths the business cycle 经济周期, aiming for two things.
- Full employment 充分就业: pull real output back to potential GDP 潜在GDP, so unemployment returns to its natural rate.
- Price stability 价格稳定: keep inflation low and steady.
Select both goals of stabilization policy.
Stabilization aims for full employment and price stability.
Stabilization policy tries to pull real output back to ______ GDP.
At potential GDP, unemployment is at its natural rate.
Combining the tools
- Fiscal and monetary policy can be combined for a stronger effect.
- Worked idea. An economy is in a recessionary gap: output is 1,000b, potential is 1,080b.
- The central bank buys bonds (rate 5% → 3%, lifting investment) and the government cuts taxes (lifting consumption).
- Both shifts push AD right, so the joint policy closes the gap faster than either tool alone.
To fight a deep recession, a tax cut and lower interest rates together shift AD further right than either alone.
Both are expansionary, so their rightward shifts add up.
Fiscal and monetary policy both shift AD, and can be combined. The monetary chain is money supply ↑ → interest rate ↓ → investment ↑ → AD →. Stabilization policy targets full employment and price stability by pulling output back to potential.