Factors Influencing the Mix of Fiscal and Monetary Policy

The lack of a good quality, trained workforce (or a modern capital infrastructure) is an impediment to growth; thus, an expansion in government spending in these areas may be a high priority.

The mix of policies will be heavily influenced by the political context.

Both fiscal and monetary policies suffer from lack of precise knowledge of where the economy is today.

Fiscal policies are difficult to implement quickly. In addition, it is politically easier to loosen fiscal policy than to tighten it.

Ricardian equivalence: if tax cuts have no impact on private spending as individuals anticipate future higher taxes, then clearly this may lead policymakers to favour monetary tools.

Important policy conclusions from an IMF study:

No monetary accommodation: Real interest rates rise as AD and inflation rise. Effect on GDP: Government spending increases (six times bigger) > similar size social transfers; targeted social transfers to the poorest > labor tax reductions > non-targeted transfers.

Monetary accommodation: Except for the case of the cut in labor taxes, fiscal multipliers are much larger than when there is no monetary accommodation.