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Is Monetary Policy More Effective For Stabilization Of An Economy?

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Compared to fiscal policy, monetary policy operates much more indirectly on the economy. Whereas an expansive fiscal policy puts more money right into the hands of consumers and businesses, monetary policy affects spending by altering interest rates, credit conditions, exchange rates, and the asset prices. In the early years of the Keynesian revolution, some macroeconomists were skeptical about the effectiveness of monetary policy, just as they were enthusiastic about the newfound tool of fiscal policy. But over the last two decades the Federal Reserve has adopted a more active role and shown itself quite capable of slowing or speeding up the economy.

The Federal Reserve is much better placed to conduct stabilization policy than are the fiscal policy makers. Its staff of professional economists can recognize cyclical movements as well as anyone. And it can move quickly when the need arises. For example, on January 28, 1994 the Commerce Department announced that the economy was growing surprisingly rapidly at year-end 1993; only a week later the Federal Reserve moved to slow the expansion by raising interest rates for the first time in half a decade.

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