Question

Using the U.S. as an example, explain why rising budget deficits on the part of a federal government creates a potential point of conflict between fiscal and monetary policymakers.

Answer 1

Whenever there is a recession in the economy, government can use fiscal policy of increasing government expenditure or reducing taxes to provide the required stimulus to aggregate demand. The same can also be done with monetary policy. However, if there are already increasing budget deficits on the part of government, fiscal policy makers are reluctant to provide any fiscal stimulus because it will eat further increase the budget deficit. Monetary policy makers are reluctant to provide the entire stimulus on their own because this will require a greater fall in the rate of interest which is not conducive for the long run growth. Monetary policy makers are happy if the government uses its fiscal expansion along with monetary expansion policy. However they are reluctant to use only monetary policy to solve economic issues.