Running tight monetary policy against expansionary fiscal policy can be expected to

Question

Quizplus · Accepted Answer

Running tight monetary policy (which typically involves raising interest rates to control inflation) against expansionary fiscal policy (which involves increasing government spending or cutting taxes to stimulate the economy) can have complex effects. It can accelerate the contraction of private investment due to higher interest rates, which makes borrowing more expensive. This situation can also affect inflationary expectations and the dynamics of achieving long-run equilibrium at potential GDP. The interaction between these policies can indeed diminish the likelihood of needing inflation to rebalance the economy and reduce the role of inflationary expectations in achieving equilibrium. Additionally, the effectiveness of tight monetary policy in lowering inflation through inducing a recession can be diminished, as expansionary fiscal policy might counteract some of the contractionary effects of higher interest rates.

Running Tight Monetary Policy Against Expansionary Fiscal Policy Can Be