The combination of monetary and fiscal policies play a strategic role in economic stabilization through the balance of aggregate supply and demand. When inflationary pressures intensify, stabilization policy is directed towards the suppression of aggregate demand. However, conversely, if the economy experiences a recession, stabilization policy is directed towards stimulating demand. Although monetary and fiscal policies affect economic conditions and structure differently, both can be used simultaneously to achieve internal equilibrium (price stability) and external equilibrium (balance of payments), two differing stabilization goals. Against this favorable backdrop, fiscal and monetary policy can indeed be managed or coordinated in such a way to produce stimuli which impact the economy positively but in a way that does not over-stimulate the economy. It is of the policy-makers' utmost interest that the result is price stability coupled with a healthy balance of payments.

Practically speaking, coordination of monetary and fiscal policy becomes more important when high uncertainty abounds regarding the impact of each policy. The importance of coordination in this respect was obvious in both developed and emerging market countries during the early 2000s when the global economy experienced a downturn and high uncertainty stemmed from existing policies. We saw how monetary policy lowered the interest rate to its nadir during that period. However the partial and biased policies of the time only propelled uncertainty and exacerbated the risks, which in return triggered a further slowdown in economic performance. For that reason, numerous economists suggested the best strategy to follow was through policy coordination and more aggressive use of policy instruments to support policy effectiveness.

QUESTIONS:

1. What are the policy instruments available for the Fiscal Authority and the Monetary Authority to handle inflationary pressures?
2. In the 1990s, as output fell and unemployment rose in Japan, the level of interest rates was cut to zero and the government ran large deficits; output remained depressed. Does this show that stabilization policy if ineffective?