Answer to Question #93761 in Macroeconomics for Sani

Question

What are the possible explanation for the recent failure of fiscal and monetary policy to solve the stagflation problem?

Answer 1

Stagflation is linked to inflation of both demand and supply. Stagflation often occurs due to cost push inflation resulting from an increase in production cost. The rise in cost may be as a result government policies or external factors such as shortage of resources. Thus the structural imperfections in the market where monopolies are dominant lead to the inability by policy makers to cause changes in their prices.

When an expansionary monetary policy is implemented it increases payment deficit as local products become cheaper at the global market thus raising their demand, thus resulting to inflation. Thus the effect of any stabilizing efforts by both monetary and fiscal policies depends on its impact on the balance of payment. Thus, these policies will not be effective in a market dominated by monopolies.