Text says : If monetary is restrictive and fiscal is stimulative, the yield curve is flat and the economy is unclear.
But, - If monetary is restrictive, we have ↑Interest rates, ↑demand for domestic currency, ↑appreciate currency. - If expansionary fiscal policy, we have ↑Gov borrowing. ↑Real IR ↑ Demand for domestic currency. ↑Appreciate currency. Financial flows effect
Why then is economy unclear when both are saying there will be an increase in I.R?
If you see from an economic point of view, restrictive monetary policy (higher interest rates) is meant to cool down the economy. On the other hand, expansionary fiscal policy is meant to create more demand and provide boost for growth and economy. So, together it is an offsetting effect and it is unclear which way economy will go.
But expansionary fiscal equates to higher interest rates, which reduces economic activity? I guess if we don’t look at it from an interest rate perspective, then i agree with their statement that it is unclear.
Expansionary fiscal policy means higher government spending (eg on infrastructure, John Boehner’s tan products,… ), from freshly printed money (eg Quantitive Easing), or from budget exposure (running at deficit).
That’s monetary policy, not fiscal policy.
Yup. Left brain right brain dilemma . Instead of QE, use taxation
Restrictive monetary policy aims to restrict the supply of money in the economy, and as a result expectations of future economic growth decrease. While the short-term higher interest rate may cause the short end of the curve to go up, the long end comes down as expectations of future economic stregth decline. Hence, the curve is flattening.
Expansionary fiscal policy will increase future expectations of growth, pushing up the long end of the yield curve The monetary policy effect tends to be stronger though (hence why expansionary monetary with contracting fiscal will still result in an upward sloping curve).
With regards to interest rates, they only increase due to fiscal expansion if the economy overheats, it’s a secondary effect. With monetary policy it’s a primary effect, as if the supply of money goes down the price for it (interest rates) must go up.
How about Expansionary Monetary policy and restrictive Fiscal policy?
Upward? Given interest rate can be manipulated to negative but long end is impossible?
Matt Mania has a good explanation on the interest rate part. I agree that some of the questions are close calls.
From an economic growth standpoint, expansionary monetary leads to lower rates and higher growth, while restrictive fiscal leads to lower government spending and lower growth. These are offsetting, so economy is unclear. But why does the text say this would lead to a moderately steep yield curve? I would have thought expansionary monetary would lead to lower short-term rates, while restrictive fiscal means lower growth now and so higher chance of a rate cut later (so long end rates are low), with the result being a moderately negative yield curve?
Mark it
@S2000magician , in mock 5 q12A,
you say that real interest rates are predicted to be high because of loose fiscal policy. Doesn’t that contradict the curriculum?
No.
Look at the 2020/2021 Level III curriculum, volume 2, reading 10, § 3.5.4, p. 203, Exhibit 5: in the column headed “Loose (Fiscal Policy)” each row reads, in part, “High Real Rates”.