The key indicators of the economic gap that exist in the country of Lalaland is the fact that some of the monetary and/or fiscal policies that could have been used might have failed to maintain the economy. Taking inflation level into account, it should be understood that this is something that evolves when the economy continues to grow because of increased expenditure. Therefore, what that suggests for the country of Lalaland is the fact that as the prices continues to rise; the currency of the state will lose its value. As a result of that, its exchange rates will be weakened as compared to the currencies of other states. Despite that, it should be understood that some of the methods that can be used to control high inflation might work well or induce damaging effects. For instance, using price and wage controls to manage inflation can cause job losses or recession (Jordi, 2011). The reason for that is because from economic perspective, inflation is perceived to be one of the factors that occur as the economy grows due to increased government expenditure. Basically, inflation evolves when the supply of money in the economy is excess. For instance, as the prices of goods and services continue to rise, it is possible for state currency to lose its value which in return weakens its exchange rates as compared to that of other countries (Rphanides & Williams, 2010). It is this scenario that results to unemployment and slower economic growth.
To counter the effect of high inflation, one of the best monetary policies that can to be used by the country of Lalaland is the contractionary monetary policy. This is to imply that, in order to be in the position of countering the effect of inflation, such an economic policy will be intended at managing the supply of money within the country (Mishkin, 2007). This is done through increasing the interest rates which in return will assist in minimizing expenditure and credit lending hence decreasing consumer spending. Such a strategy is important because it has been acknowledged as to have the potential of halting economic growth (Rphanides & Williams, 2010). By using such an economic policy, it will give the state the capacity of determining whether it matches with the existing monetary policies so as to restore the economy. The reason for that is because in doing so it will become possible for the state to enhance equitable economic development (Akhand, 2013).
In order to stimulate the economy, the government can also decide to use fiscal policy as one of the actions of stimulating the economy through taxation and expenditure. So as to be in the position of eliminating such the inflationary gap, the government can decide to decrease expenditure and in return increase or decrease taxes. Since this is one of the economic intervention through which the government uses to inject its policies, the aim will entail expanding or contracting economic growth (Alan, 2001). For instance, the country can take the option of pursuing an expansionary fiscal policy as a means of fostering employment. This can be done through decreasing taxes as well as increasing government expenditure (Jordi, 2011). Lowering taxes will have the likelihood of increasing disposable income which in return aid in increasing consumption. Therefore, through altering the level of taxation and expenditure, the government will be in the position of affecting aggregate demand directly or indirectly.
References
Akhand, A.H. (2013). Macroeconomic and Monetary Policy Issues in Indonesia: Routledge Studies in the Growth Economies of Asia. Routledge, 2013
Alan, A. R. (2001). Handbook of Monetary and Fiscal Policy: Public Administration and Public Policy. CRC Press
Jordi, G. (2011). Unemployment Fluctuations and Stabilization Policies: A New Keynesian Perspective. MIT Press
Mishkin, F. S. (2007). Monetary policy strategy. Cambridge, Mass: MIT Press.
Rphanides, A., & Williams, J. C. (2010). Monetary Policy Mistakes and the Evolution of Inflation Expectations. London: Centre for Economic Policy Research.
