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Dictionary of Economics

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Monetary Offset

What is monetary offset?

Monetary offset occurs when a central bank responds to expansionary fiscal policy with contractionary monetary policy, and offsets fiscal policy effects.

Sound complicated? Let’s walk through an example.

When a government increases spending (fiscal policy), inflation increases. How does the central bank react? They may choose to counteract the expansionary fiscal policy by contracting the money supply (monetary policy).

In other words, the monetary policy is partially offsetting the fiscal policy.

As you can see, fiscal policy can be tricky. We have to take into account how other institutions, such as the central bank, will react to and offset fiscal policy.

Interested in learning more about fiscal policy, check out Marginal Revolution University’s Principles of Macroeconomics course section on fiscal policy.

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Transcript

What is monetary offset? Monetary offset occurs when a central bank responds to expansionary fiscal policy with contractionary monetary policy and offsets fiscal policy effects. Let's look at an example.

 

When a government increases spending, the aggregate demand curve shifts out, which increases inflation. Now, central banks often try to stabilize prices. So if this expansionary policy shifts the aggregate demand curve out, increasing inflation, the central bank might choose to contract the money supply. This contractionary policy shifts the aggregate demand curve inwards. In other words, monetary policy could partially offset or reverse the fiscal policy expansion.

 

Monetary offset is just one reason fiscal policy can be so complicated. It's not just a matter of increasing government spending. We also have to take into account how others, such as the central bank in this instance, respond to fiscal policy.

 

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