Monetary, Fiscal, and Incomes Policy and Inflation

Monetary policy affects the supply of money (basically currency plus commercial bank demand deposits) and the rate of interest. Fiscal policy includes the rate of taxation and level of government spending. Incomes policy consists of anti-inflation measures that depend on income and price limitations, such as moderated wage increases. The DC governments use monetary and fiscal policies to achieve goals for output and employment growth and price stability. Thus, during a recession, with slow or negative growth, high unemployment, and surplus capital capacity, these governments reduce interest rates, expand bank credit, decrease tax rates, and increase government spending to expand aggregate spending and accelerate growth. By contrast, DC governments are likely to respond to a high rate of inflation (general price increase) with increased interest rates, a contraction of bank credit, higher tax rates, decreased government expenditures, and perhaps even wage–price controls in order to reduce total spending. The DCs often do not attain their macroeconomic goals because of ineffective monetary and fiscal tools, political pressures, or contradictory goals. Thus, we have the quandary during stagflation or inflationary recession (a frequent economic malady in the West during the 1970s and 1980s) of whether to increase aggregate spending to eliminate the recession or decrease spending to reduce inflation.