Cyclical Fluctuations in the Economy - Essay Example

The supply side shocks such as the improvements in technology or the raging oil prices affect the costs and prices in different countries. These supply side policies may then have an internal affect on the interest rates, exchange rates etc to becoming either beneficial or causing damage in the own country. In effect the cyclical fluctuations in the economy may be expected, however activities are so interconnected that changing one variable for the better usually upsets other variables. These cyclical fluctuations can be divided into 4 consequences.

These consequences are handled by the macroeconomic policy of the government. (objectives of government macroeconomic policy, 2008) These objectives seem hard to achieve in the light of the cyclical fluctuations in the economy, however the government needs to apply the macroeconomic policies with hindsight and foresight to fully reap the benefits of the economic system. The main objective that all governments want to at least achieve is to increase the growth rate of the country without increasing the inflation.

This is the real growth, while with inflation the growth is cancelled out with the rising prices of commodities. Monetary policy is "the policy carried out by the central bank to manipulate interest rates and credit conditions, in order to influence the general level of economic activity. Monetary policy is a powerful tool for influencing the level of employment, economic growth and the rate of inflation." (GOIAM)The government should lower the interest rates. This will eventually direct the growth towards the rise in consumer and business capital spending.

When this happens the national income rises making the people spend more and increase the economic activity. Since investment spending results in a larger capital stock, then incomes in the future will also be higher through the impact on LRAS. The people would spend more rather than keeping the money in the banking systems as the return on investment isn't high. With the increased economic activity, the country will boom and the growth will increase. Eventually this growth would need to be sustained, which can be done through the use of microeconomic policies such as supply side and monetary policies (GOIAM).

Therefore when the interest rates need to be reduced without changing the inflation rate by using the expansionary monetary policy, the aggregate demand will increase. On the other hand if a contractionary monetary policy is used, the spending will decrease and the aggregate demand will decrease. (Weerapana, 2002)(Source: Weerapana, 2002)Fiscal PolicyFiscal policy is the policy used by the government to control the total level of economic activity in a country. It "involves the use of government spending, taxation and borrowing to influence both the pattern of economic activity and also the level and growth of aggregate demand, output and employment".

An expansion in fiscal policy by increasing government spending will contribute directly to aggregate demand. This demand is good for the country as it would give an opportunity to the industry to boom and make more efficient use of their systems to cater to the demand. However if the government spendi