Limitations to monetary policy restricting the economic growth

The belief grew that positive action by governments might be required as well. The doctrine was first related to monetary policy in particular.

Limitations to monetary policy restricting the economic growth

Read this article to learn about the differences between the limitations of monetary policy and fiscal policy. Tools of fiscal policy like budget, taxation, public spending and debt have great practical limitations and give rise to certain fundamental problems.

These difficulties are mainly three. The effectiveness of fiscal policy depends on the size of the measures adopted and their timing. For example, what is the exact amount of expenditure that should be incurred or the revenue that should be raised at a given time is more than any fiscal authority can foresee.

Then, there are political and administrative delays in taking measures especially when legislative sanction is needed for changing the rates and structure of taxes or expenditure on programmes.

The success of fiscal measures depends also upon the redistribution of income and a chain of economic and psychological reactions on the part of the people as a result of these measures. Again, the effects of an increase in government expenditure are counteracted, to some extent, by an increase in the value of imports and a decline in the value of exports, thereby reducing the multiplier effects.

Moreover, the funds for increased expenditure should be raised in such a way as would not depress investment in industries of the private sector. If a government demand for labour and raw materials come in competition with private industries, the latter would suffer indefinitely.

Hence, government spending should be such as to supplement and not supplant private investment. Further, government spending may not be in the direction of correcting maladjustments caused by depression and may even be neutralized by factors working in the opposite direction such as structural unemployment.

The entire fiscal armory has to be made use of with great care. Thus, the effectiveness of fiscal policy is impaired to a considerable extent by the choice of policy lags and there timing combined with recognition, action, administrative, operational lags. Besides, there is the problem of forecasting, selectivity and adequacy of fiscal measures.

Sometimes, the various compensatory fiscal policies become mutually offsetting.

Limitations to monetary policy restricting the economic growth

Safeguards have got to be adopted against these limitations. The effectiveness or otherwise of the fiscal measures can be accurately determined by-the elasticities of IS and LM functions, as shown in the Fig.

In these models, monetary policy operates by shifting the LM function whereas fiscal operates by shifting the IS function.

On the other hand, a shift of the IS function to the right will cause a small expansion in income and a greater rise in the rate of interest from Y0 to Y2 and the rise from r0 to r1.

This clearly shows that the monetary policy is quite effective during inflation. But when tax reduction or increase in public spending shifts the IS function from IS0 to IS1— income expands from Y0 to only Y2; while the rate of interest increases considerably from r0 to r2.

On the other hand, in Fig. The shift in the LM function will have little effect on income while significant effect on the rate of interest income will change from Y0 to Y1 and the rate of interest will change from r0 to r1. It shows the relative ineffectiveness of monetary policy.

Again, a shift in the IS function to the right will cause more changes in income while the rate of interest changes slightly income changes from Y0 to Yi and the rate of interest varies from r0 to r1. This shows a greater effectiveness of fiscal policy.Monetary policy is the process by which the monetary authority of a country, typically the central bank or currency board, controls either the cost of very short-term borrowing or the monetary base, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency..

Further goals of a monetary policy are usually to contribute to the stability of. Limits to monetary policy’s influence on labor markets. Although monetary policy plays an important role in promoting maximum employment, it does not play the most important role. The reason the FOMC has not specified a fixed goal for employment is that, while long-run inflation is primarily determined by monetary policy, nonmonetary factors largely determine the maximum level of employment and the .

Note that while both speed limit estimates are above the average annual growth rate of % for , they are below both the average annual growth rate of % observed since the current economic expansion began in , and the % average annual growth rate observed since , when the unemployment rate fell below 10% for the first time since the recession.

Recession is a result of widespread downturn in economic activity and the government could react by the use of expansionary monetary policy which involves reducing banks’ reserve requirements, by lowering interest rates to increase money supply and boost economic growth.

Limitations to monetary policy restricting the economic growth

This policy could also be applied contractionary, to control the rise in demand by increasing the interest rates thus reducing the supply . Though monetary policy influences other variables, control of quantity of money is considered to be the key variable in the monetary policy.

Anyway, monetary policy is defined as the central bank’s use of control of money supply or interest rates (i.e., the price of money) or the rationing of credit sanctioned by banks to influence the level of economic activity.

Monetary policy is the process by which the monetary authority of a country controls the supply of money with the purpose of promoting stable employment, prices, and economic growth. Monetary policy can influence an economy but it cannot control it directly. There are limits as to .

Limitations of Monetary Policy and Fiscal Policy