Hello community,

What is the most likely outcome if expansionary fiscal policy is combined with contractionary monetary policy?

and the answer is: Expansionary fiscal policy combined with contractionary monetary policy results in higher aggregate output, higher interest rates and increased government spending as a part of GDP.

My question is: does fiscal policy always outweighs monetary policy? Because an expansionary fiscal policy will shift AD to the right and a contractionary policy will shift AD to the left, so if they have the same impact, they would cancel each other.

Thanks!

Greetings friend!

Basically it looks like this:

Stimulative monetary and fiscal policy together = sharp upward sloping yield curve (long-term interest rates/yields are significantly higher than short-term rates/yields).

Restrictive monetary and fiscal policy together = downward sloping (inverted) yield curve (short-term interest rates/yields are higher than long-term rates/yields).

Stimulative monetary + restrictive fiscal policy = moderately upward sloping yield curve

Restrictive monetary + stimulative fiscal policy = flat yield curve

Usually the expected yield curve is upward sloping (longer maturity bonds compensate investors with higher yields than shorter maturity ones, all else being equal). So when it goes flat it means short-term interest rates/yields probably have increased a bit and medium-term and long-term rates/yields either stay the same or decrease down to a make a flat level with the increased short term rates. The various rates rise/fall at different points in the yield curve to meet each other in a flat line.

That may be what the question answer, that you cite to above, is explaining (rising “short-term” interest rates). In terms of Increasing government spending, that is part of stimulative fiscal policy by definition. More government spending likewise can cause higher output due to subsidies into industry, and it can also be helped by tax breaks from tax cuts (also stimulative fiscal policy).

Cheers and good on your exam - you got this

ok so if I get it right the increase in the interest rates and output with the fiscal policy are more important than the increase in interest rate and decrease in output from the contractionary monetary policy, resulting in a higher output at the end. This is due to the short term rates on the yield curve being higher or equal to the medium/long term rates.

Thanks man! Having the exam this Monday