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“Public policy must devise some measures to counteract these fluctuations and to ensure economic stability” therefore the Feds will step in and work to stabilize the economy through fiscal policy and money markets as a budgetary policy mechanism. (Moheeth, n.d.). The central banking system will need to work on the details or fine-tuning the economy in terms of growth and stability through monetary policy to include “cash reserve requirements, open market operation, bank rate” which can be effective through credit and monetary policy (Moheeth, n.d.). “Fiscal tools of expenditure and taxation can be adjusted in the required direction to bring stability in the economy” (Moheeth, n.d.). With all these mechanisms being put in place, the concept of long term needs to be kept at the forefront of this stabilization effort as short term is not going to work to bring the economy back into a stabilized state. Slow and steady wins the race and unfortunately that is the same for the economy and therefore it tends to take the economy so long to rebound from recessions or financial depressions. “Economists generally advocate that policymakers focus on long-run objectives such as low inflation and steady economic growth” (Hubbard & O’Brien, 2014, p. 538). The output gap is “the percentage difference between real GDP and potential GPD” while the inflation gap is “the difference between the current inflation rate and a target rate” (Hubbard & O’Brien, 2014, p. 561). Changes in real interest rate can have an affect the “level of investment, consumption, and net exports relative to potential GDP” (Hubbard & O’Brien, 2014, p. 561). If the Feds were to lower the interest rate than the consumption, investment and net export levels will increase causing an increase in real GDP relative to potential GDP which will leave the IS-MP sloping downward when graphed. The MP portion is when the Feds or the FOMC make the determination to lower the target for the federal funds rate in this example which it will also lower long-term and short-term interest rates.
In the current phase the central banks are faced with twin problem of stable growth and moderate inflation . So the central bank has two options ine fiscal policy and monetary policy. Generally the policy makers are focussed on long term parameters. This is because in long term only the effects of policies can be witnessed.Due to opening of economy the policy in one part of globe has reprecursions on other part. So the job of policy makers is not at all easy . They have to maesure the cost and benefits of policy before undertaking any policy.
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