Question

What is the distinction between monetary and fiscal policy? Give an account in terms of the Hicks- Hansen (IS-LM model). Why might these be useful?

Answer 1

Monetary policy is a policy by which the central bank or Fed controls the liquidity to manage the economy,i.e.,by changing the supply of money in the economy.

LM is associated with the monetary policy.If central bank increases money supply then LM shifts to the left increases income and output in the economy and vice-versa

Fiscal policy is referred to government policy of taxation,transfer payments,and spending to manage the economy.The IS curve is associated with fiscal policy It shows the relationship between investment and interest rate.When government undertake a fiscal expansion,the IS curve shifts to the right increases income and output by increasing aggregate demand.

IS-LM is very useful as this model gives a framework of how the monetary authority and the government should work in order to stabilize the economy.