Limitations of fiscal policy in an incomplete market

Policy effectiveness in relation to economic growth

The interaction between fiscal and monetary policies was a much-debated issue between Keynesians and Monetarists. According to post- Keynesian mainstream economics, in macroeconomic regulation the government should, except in times of crisis, avoid adopting fiscal and monetary policies that are tight or loose at the same time. A better choice is to pair tight fiscal policy with loose monetary policy, or loose fiscal policy with tight monetary policy. Monetarists, in principle, are not opposed to the interaction between fiscal and monetary policies, but they maintain that fiscal policy has great limitations. For example, a loose fiscal policy may not achieve the expected goals because fiscal expansion tends to partially “crowd out” private consumption and private investment, but if fiscal policy is tight, it cuts into the economic growth rate, resulting in fiscal expenditure cutbacks that invariably bring down fiscal revenue, thereby diverting the fiscal policy from its prescribed goals. Consequently, they believe that monetary policy is more effective than fiscal policy. Such is the basic policy preference of Monetarists.

In a policy debate with Monetarists, Keynesians further argue that the coordination between fiscal and monetary policies should be discussed in combination with economic policy goals. To be specific, they argue that it is necessary to observe the effects of the coordination between these two policies from the perspective of whether it is conducive to economic stability and sustainable growth.