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Monetary-Fiscal Mix

 Monetary-Fiscal Mix

   Let us assume a condition where an expansionary mix of monetary and fiscal strategies is followed to accomplish full employment in the fiscal system. This is described in the nominal condition at point A on the base of the intersection of IS1 and LM1 curves.

    This condition shows OR2 rate of interest and OY1 earnings level. Now an expansionary fiscal strategy is followed in the form of enhancement in government outlay or decline in taxes.

    This moves the curve IS1 to IS2. This will possess the consequence of raising the rate of interest in addition to OR3 is an expansionary monetary strategy is not followed concurrently.

    Hence with a view to decrease the rate of interest and motivate investment for accomplishing full employment the monetary authority enhances the supply of money through open market purchase of securities.

    This is likely to move the curve LM1 to the right in the position of LM2 curve. Now fiscal strategy has tended to the new IS2 curve and monetary strategy to the LM2 curve.

     Both the curves overlaps at B whereby the rate of interest is lessen to OR1 and the earnings level enhances to the full employment level OYF.

     Let us consider another condition when the financial system at full employment level of earnings OYF where the IS curve overlaps the LM curve at the E point in the below given diagram.

    But owing to some causes the financial system’s development hikes ha slowed down. With a view to triumph over this, more investment is needed to be made in the financial system.

    For this, the monetary authority enhances the supply of money which tends to the movement of the curve LM to the right to LM1. The LM1 curve overlaps the IS curve at the E point which lowers the rate of interest to OR1 and hikes the earnings level to OY1.

    However the hike in national earnings being huger then the whole employment earnings level, this strategy is inflationary. Thus the financial system needs a variation in the monetary fiscal mix.

    For this, the expansionary monetary strategy must be mixed with a limited fiscal strategy. Relatively, the government decreases its investment outlay or and enhances taxes so that the IS curve moves to the left to IS1.

    Now the IS1 curve overlaps the LM1 curve at E2 point so that the new symmetry is accomplished at a lower rate of interest OR2 and earnings level OYF which is the full employment earnings level.

    This level can be upheld by the current monetary-fiscal strategy mix for the reason that the lower rate of interest would keep outsized investment expending in the financial system and decreased government outlay or high taxes would control inflation.

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