INTRODUCTION: The project comprises of detailed study on Stabilization policies with fixed exchange rate and its history,

meaning. With special emphasis on Economic Stabilization policies in India. OBJECTIVES OF THE PROJECT: i. ii. iii. iv. To know about what is stabilization policies. To know about fiscal policy. To know about monetary policy. To know about policies with fixed exchange rate.

SCOPE OF THE STUDY: The scope of stabilization of policies presented data and analysis on fixed exchange rate across fiscal policy, monetary policy by aggregating information from multiple government data

sources, creating searchable data sets, and providing sector-specific analyses. METHODS OF DATA COLLECTION: The data is collected from secondary sources and has taken from different websites, articles and journals. CHAPTER SCHEME: The project consist of following chapters as followsChapter 1 : History of Stabilization of Policies.

Chapter 2: Capital Mobility and Stabilization Polices under Fixed and Flexible Exchange Rates . Chapter 3: What is Fiscal policy and Monetary Policy? Chapter 4:Fiscal policy vs Monetary policy. LIMITATIONS OF THE STUDY: The study has been undertaken only on Stabilization policies with fixed exchange rate in India. The implementation of its other developing countries and least developing countries is not taken into consideration and thats the major constraint.

History of stabilization policy

The use of fiscal and monetary policy as a means of stabilizing the economy is relatively recent, for the most part a development of the period after World War II. During the 19th century the only stabilization policy was that associated with the international gold standard. Under the gold standard, if a deficit occurred in a countrys balance of payments, gold tended to flow out of the country. To counteract this process, the monetary authorities would raise interest rates and stiffen credit requirements, causing a fall in prices, income, and employment; this in turn led to a reduction in imports and an expansion of exports, thus improving the balance of payments. If a country had a surplus in its balance of payments, gold tended to flow in; this meant that the interest rate fell and the supply of money and credit was increased. As a consequence, imports were stimulated and exports discouraged so that the surplus in the balance of payments tended to disappear. The adjustment mechanism also included another important element: capital movements between countries. When interest rates fell in surplus countries and rose in deficit countries, mobile international financial.

Definition of 'Stabilization Policy'

A macroeconomic strategy enacted by governments and central banks to keep economic growth stable, along with price levels and unemployment. Ongoing stabilization policy includes monitoring the business cycle and adjusting benchmark interest rates to control aggregate demand in the economy. The goal is to avoid erratic changes in total output, as measured by Gross Domestic Product (GDP) and large changes in inflation; stabilization of these factors generally leads to moderate changes in the employment rate as well.

Investopedia explains 'Stabilization Policy

Stabilization policies are also used to help an economy recover from a specific economic crisis or shock, such as sovereign debt defaults or a stock market crash. In these instances stabilization policies may come from governments directly through overt legislation, securities reforms, or from international banking groups, such as the World Bank. As economies become more complex and advanced, top economists believe that maintaining a steady price level and pace of growth is the key to long-term prosperity. When any of the aforementioned variables becomes too volatile, there are unforeseen consequences and effects to the broad economy that keep markets from functioning at their optimum level of efficiency. Most modern economies employ stabilization policies, with much of the work being done by central banking authorities like the U.S. Federal Reserve Board. Stabilization policy is largely credited with the moderate but positive rates of GDP growth seen in the United States since the early 1980s.

Capital Mobility and Stabilization Polices under Fixed and Flexible Exchange Rates.

The world is still a closed economy, but its regions and countries are becoming increasingly open. The trend, manifested in both freer movement of goods and increased mobility of capital, has been stimulated by the dismantling of trade and exchange controls in Europe, the gradual erosion of the real burden of tariff protection, and the stability, unparalleled since 1914, of the exchange rates. The international economic climate has changed in the direction of financial integration and this has important implications for economic policy.

Sectoral and Market Equilibrium Conditions

The assumption of perfect capital mobility can be taken to mean that all securities in the system are perfect substitutes. Because different currencies are involved, this implies that existing exchange rates are expected to persist indefinitely (even when the exchange rate is not pegged) and that spot and forward exchange rates are identical. All the complications associated with speculation, the forward market, and exchange-rate margins are thereby assumed not to exist.

To focus attention on policies affecting the level of employment, we assume unemployed resources, constant returns to scale, and fixed money wage rates; this means that the supply of domestic output is elastic and its price level constant. We assume further that saving and taxes rise with income, that the balance of trade depends only on income and the exchange rate, that investment depends on the rate of interest, and that the demand for money depends only on

income and the rate of interest. Our last assumption is that the country under consideration is too small to influence foreign incomes or the world level of interest rates.

Monetary policy will be assumed to take the form of open market purchases of securities, and fiscal policy the form of an increase in government spending (on home goods) financed by an increase in the public debt. Floating exchange rates result when the monetary authorities do not intervene in the exchange market, and fixed exchange rates when they intervene to buy and sell international reserves at a fixed price.

Policies under Flexible Exchange Rates

Under flexible exchange rates the central bank does not intervene to fix a given exchange rate, although this need not preclude autonomous purchases and sales of foreign exchange.

MONETARY POLICY

Consider the effect of an open market purchase of domestic securities in the context of a flexibleexchange-rate system. This results in an increase in bank reserves, a multiple expansion of money and credit, and downward pressure on the rate of interest. But the interest rate is prevented from falling by an outflow of capital, which causes a deficit in the balance of payments, and a depreciation of the exchange rate. In turn, the exchange-rate depreciation (normally) improves the balance of trade and stimulates, by the multiplier process, income and employment. A new equilibrium is established when income has risen sufficiently to induce the domestic community to hold the increased stock of money created by the banking system. Because interest rates are unaltered, this means that income must rise in proportion to the

increase in the money supply, the factor of proportionality being the given ratio of income and money (income velocity).

In the new equilibrium private saving and taxes will have increased as a consequence of the increase in income, and this implies both net private lending and retirement of government debt. Equilibrium in the capital market then requires equality between the sum of the net private lending plus debt retirement, and the rate of capital exports, which in conjunction with the requirement of balance-of-payments equilibrium, implies a balance of trade surplus. Monetary policy therefore has a strong effect on the level of income and employment, not because it alters the rate of interest, but because it induces a capital outflow, depreciates the exchange rate, and causes an export surplus.5

It will now be shown that central bank operations in the foreign exchange market ("open market operations" in foreign exchange) can be considered an alternative form of monetary policy. Suppose the central bank buys foreign reserves (gold or foreign currency) with domestic money. This increases bank reserves, causing a multiple expansion of the money supply. The monetary expansion puts downward pressure on the interest rate and induces a capital outflow, further depreciating the exchange rate and creating an export surplus, which in turn increases, through the multiplier effect, income, and employment. Eventually, when income has increased sufficiently to induce the community to hold the increased stock of money, the incomegenerating process ceases and all sectors are again in equilibrium, with the increased saving and taxes financing the capital outflow. This conclusion is virtually the same as the conclusion earlier reached regarding monetary policy, with the single important difference that foreign assets of the banks are increased in the case of foreign exchange policy while domestic assets are increased in

the case of monetary policy. Foreign exchange policy, like monetary policy, becomes a forceful tool of stabilization policy under flexible exchange rates.

FISCAL POLICY

Assume an increase in government spending financed by government borrowing. The increased spending creates an excess demand for goods and tends to raise income. But this would increase the demand for money, raise interest rates, attract a capital inflow, and appreciate the exchange rate, which in turn would have a depressing effect on income. In fact, therefore, the negative effect on income of exchange-rate appreciation has to offset exactly the positive multiplier effect on income of the original increase in government spending. Income cannot change unless the money supply or interest rates change, and because the former is constant in the absence of central bank action and the latter is fixed by the world level of interest rates, income remains fixed. Since income is constant, saving and taxes are unchanged, which means, because of the condition that the goods market be in equilibrium, that the change in government spending is equal to the import surplus. In turn, the flexible exchange rate implies balance-of-payments equilibrium and therefore a capital inflow equal to the import surplus. Thus, both capital and goods market equilibria are assured by equality between the rate of increase in the public debt and the rate of capital imports, and between the budget deficit and the import surplus. Fiscal policy thus completely loses its force as a domestic stabilizer when the exchange rate is allowed to fluctuate and the money supply is held constant. Just as monetary policy derives its importance as a domestic stabilizer from its influence on capital flows and the exchange rate, so fiscal policy is frustrated in its effects by these same considerations.

Policies under Fixed Exchange Rates

Under fixed exchange rates the central bank intervenes in the exchange market by buying and selling reserves at the exchange parity; as already noted the exchange margins are assumed to be zero.

MONETARY POLICY

A central bank purchase of securities creates excess reserves and puts downward pressure on the interest rate. But a fall in the interest rate is prevented by a capital outflow, and this worsens the balance of payments. To prevent the exchange rate from falling, the central bank intervenes in the market, selling foreign exchange and buying domestic money. The process continues until the accumulated foreign exchange deficit is equal to the open market purchase and the money supply is restored to its original level.

This shows that monetary policy under fixed exchange rates has no sustainable effect on the level of income. The increase in the money supply arising from open market purchases is returned to the central bank through its exchange stabilization operations. What the central bank has in fact done is to purchase securities initially for money, and then buy money with foreign exchange, the monetary effects of the combined operations canceling. The only final effect of the open market purchase is an equivalent fall in foreign exchange reserves: The central bank has simply traded domestic assets for foreign assets.

FISCAL POLICY

Assume an increase in government spending superimposed on the foreign exchange policy of pegging the exchange rate. The increased spending has a multiplier effect upon income, increasing saving, taxes, and imports. Taxes increase by less than the increase in government spending, so the government supplies securities at a rate equal to the budget deficit, whereas the private sector absorbs securities at a rate equal to the increase in saving.

After the new equilibrium is established, both the goods and capital markets must be in balance. In the goods market the budget deficit has as its counterpart the sum of the excess private saving over investment and the balance-of-trade deficit, which implies that the induced balance-of-trade deficit is less than the budget deficit. In the capital market the private and foreign sectors must be willing to accumulate the new flow of government issues. But, because the excess private saving is equal to the flow of private lending, and because the budget deficit equals the flow of new government issues, capital market equilibrium requires that the import deficit be exactly balanced by a capital inflow, so that there is balance-of-payments equilibrium after all adjustments have taken place.

There will nevertheless be a change in foreign exchange reserves. Before the flow equilibrium is established the demand for money will increase, at a constant interest rate, in proportion to the increase in income. To acquire the needed liquidity the private sector sells securities and this puts upward pressure on the interest rate and attracts foreign capital. This improves the balance of payments temporarily, forcing the central bank to intervene by buying foreign reserves and increasing the money supply. The money supply is therefore increased indirectly through the back door of exchange rate policy. Foreign exchange reserves accumulate by the full amount of

the increased cash reserves needed by the banking system to supply the increased money demanded by the public as a consequence of the increase in income.

Other Policy Combinations

Other cases deserve attention in view of their prominence in policy discussion. In the following cases it is assumed that exchange rates are fixed.

DEFICIT FINANCE

An important special case of combined operations of monetary, fiscal, and exchange policies is central bank financing of budget deficits (deficit finance) under fixed exchange rates. As before, the increase in government spending yields a multiplier effect on income. In the new equilibrium there is a budget deficit, an excess of saving over investment, and a balance-of-trade deficit. The government issues securities at a rate equal to the budget deficit and these are (by assumption) taken up by the central bank. Capital market equilibrium therefore requires that the net flow demand for securities on the part of the private sector be equal to the net capital outflow.

It is easy to see that in the new equilibrium the balance-of-payments deficit and the consequent rate at which reserves are falling is exactly equal to the budget deficit and to the rate at which the central bank is buying government securities. Because the capital outflow is equal to the excess of saving over investment, and the loss of reserves is equal to the balance-of-payments deficit, which is the sum of the trade deficit and the capital outflow, reserves fall at a rate equal to the sum of the import deficit and the excess of saving over investment. Then because this sum equals the budget deficit, by the condition of equilibrium in the goods market, it follows that reserves fall at a rate equal to the budget deficit. The budget is entirely at the expense of reserves.

There is, however, in this instance, too, an initial stock-adjustment process. As income increases the demand for money grows, and the private sector dispenses with stocks of securities, causing a capital inflow and an increase in reserves. This increase in reserves is a once-and-for-all inflow equal to the increase in cash reserves necessary for the banks to satisfy the increased demand for money. The rate of fall in reserves takes place, therefore, from a higher initial level.

What are the main advantages and disadvantages of Fixed Exchange Rates ?
Advantages of Fixed Exchange Rates

The main arguments advanced in favor of the system of fixed or stable exchange rates are as follows:

1. Promotes International Trade:

Fixed or stable exchange rates ensure certainty about the foreign payments and inspire confidence among the importers and exporters. This helps to promote international trade.

2. Necessary for Small Nations:

Fixed exchange rates are even more essential for the smaller nations like the U.K., Denmark, Belgium, in whose economies foreign trade plays a dominant role. Fluctuating exchange rates will seriously affect the process of economic growth in these economies.

3. Promotes International Investment:

Fixed exchange rates promote international investments. If the exchange rates are fluctuating, the lenders and investors will not be prepared to lend for long-term investments.

4. Removes Speculation:

Fixed exchange rates eliminate the speculative activities in the international transactions. There is no possibility of panic flight of capital from one country to another in the system of fixed exchange rates.

5. Necessary for Small Nations:

Fixed exchange rates arc even more essential for the smaller nations like the U.K., Denmark, Belgium, in whose economies foreign trade plays a dominant role. Fluctuating exchange rates will seriously disturb the process of economic growth of these economies.

6. Necessary for Developing Countries:

Fixed exchanges rates are necessary and desirable for the developing countries for carrying out planned development efforts. Fluctuating rates disturb the smooth process of economic development and restrict the inflow of foreign capital.

7. Suitable for Currency Area:

A fixed or stable exchange rate system is most suitable to a world of currency areas, such as the sterling area. If the exchange rates of the countries in the common currency area are flexible, the fluctuations in the leading country, like England (whose currency dominates), will also disturb the exchange rates of the whole area.

8. Economic Stabilization:

Fixed foreign exchange rate ensures internal economic stabilization and checks unwarranted changes in the prices within the economy. In a system of flexible exchange rates, the liquidity preference is high because the businessmen will like to enjoy wind fall gains from the fluctuating exchange rates. This tends to Increase price and hoarding activities in country.

9. Not Permanently Fixed:

Under the fixed exchange rate system, the exchange rate does not remain fixed or is permanently frozen. Rather the rate is changed at the appropriate time to correct the fundamental disequilibrium in the balance of payments.

10. Other Arguments:

Besides, the fixed exchange rate system is also beneficial on account of the following reasons.

(i) It ensures orderly growth of world's money and capital markets and regularises the international capital movements.

(ii) It ensures smooth functioning of the international monetary system. That is why, IMF has adopted pegged or fixed exchange rate system.

(iii) It encourages multilateral trade through regional cooperation of different countries.

(iv) In modern times when economic transactions and relations among nations have become too vast and complex, it is more useful to follow a fixed exchange rate system.

Disadvantages of Fixed Exchange Rates

The system of fixed exchange rates has been criticized on the following grounds:

1. Outmoded System:

Fixed exchange rate system worked successfully under the favorable conditions of gold standard during 19th century when

(a) the countries permitted the balance of payments to influence the domestic economic policy;

(b) there was coordination of monetary policies of the trading countries;

(c) the central banks primarily aimed at maintaining the external value of the currency in their respective countries; and

(d) the prices were more flexible. Since all these conditions are absent today, the smooth functioning of the fixed exchange rate system is not possible.

2. Discourage Foreign Investment:

Fixed exchange rates are not permanently fixed or rigid. Therefore, such a system discourages long-term foreign investment which is considered available under the really fixed exchange rate system.

3. Monetary Dependence:

Under the fixed exchange rate system, a country is deprived of its monetary independence. It requires a country to pursue a policy of monetary expansion or contraction in order to maintain stability in its rate of exchange.

4. Cost-Price Relationship not Reflected:

The fixed exchange rate system does not reflect the true cost-price relationship between the currencies of the countries. No two countries follow the same economic policies. Therefore the cost-price relationship between them go on changing. If the exchange rate is to reflect the changing cost-price relationship between the countries, it must be flexible.

5. Not a Genuinely Fixed System:

The system of fixed exchange rates provides neither the expectation of permanently stable rates as found in the gold standard system, nor the continuous and sensitive adjustment of a freely fluctuating exchange rate.

6. Difficulties of IMF System:

The system of fixed or pegged exchange rates, as followed by the International Monetary Fund (IMF), is in reality a system of managed flexibility.

It involves certain difficulties, such as deciding as to

(a) when to change the external value of the currency,

(b) what should be acceptable criteria for devaluation; and

(c) how much devaluation is needed to reestablish equilibrium in the balance of payments of the devaluing country.

Fiscal Policy
Fiscal policy is the use of government spending and TAXATION to influence the economy. When the government decides on the goods and services it purchases, the transfer payments it distributes, or the taxes it collects, it is engaging in fiscal policy. The primary economic impact of any change in the government budget is felt by particular groupsa tax cut for families with children, for example, raises their disposable income. Discussions of fiscal policy, however, generally focus on the effect of changes in the government budget on the overall economy. Although changes in taxes or spending that are revenue neutral may be construed as fiscal policyand may affect the aggregate level of output by changing the incentives that firms or individuals facethe term fiscal policy is usually used to describe the effect on the aggregate economy of the overall levels of spending and taxation, and more particularly, the gap between them. The most immediate effect of fiscal policy is to change the aggregate demand for goods and services. A fiscal expansion, for example, raises aggregate demand through one of two channels. First, if the government increases its purchases but keeps taxes constant, it increases demand directly. Second, if the government cuts taxes or increases transfer payments, households disposable income rises, and they will spend more on consumption. This rise in consumption will in turn raise aggregate demand. Fiscal policy also changes the composition of aggregate demand. When the government runs a deficit, it meets some of its expenses by issuing BONDS. In doing so, it competes with private borrowers for money loaned by savers. Holding other things constant, a fiscal expansion will

raise INTEREST RATES and crowd out some private INVESTMENT, thus reducing the fraction of output composed of private investment. Fiscal policy is an important tool for managing the economy because of its ability to affect the total amount of output producedthat is, gross domestic product. The first impact of a fiscal expansion is to raise the demand for goods and services. This greater demand leads to increases in both output and prices. The degree to which higher demand increases output and prices depends, in turn, on the state of the business cycle. If the economy is in recession, with unused productive capacity and unemployed workers, then increases in demand will lead mostly to more output without changing the price level. If the economy is at full employment, by contrast, a fiscal expansion will have more effect on prices and less impact on total output.

MONETARY POLICY:
Control over the money supply and interest rates by a central bank or monetary authority to stabilize business cycles, reduce unemployment and inflation, and promote economic growth. In the United States monetary policy is undertaken by the Federal Reserve System (the Fed). In principle, Federal Reserve policy makers can use three different tools--open market operations, the discount rate, and reserve requirements--to manipulate the money supply. In practice, however, the primary tool employed is open market operations. An alternative to monetary policy is fiscal policy. Monetary policy is controlling of the quantity of money in circulation for the expressed purpose of stabilizing the business cycle and reducing the problems of unemployment and inflation. In days gone by, monetary policy was undertaken by printing more or less paper currency. In modern economies, monetary policy is undertaken by controlling the money creation process performed through fractional-reserve banking.

The Federal Reserve System (or the Fed) is U.S. monetary authority responsible for monetary policy. In theory, it can control the fractional-banking money creation process and the money supply through open market operations, the discount rate, and reserve requirements. In practice, the Fed primarily uses open market operations, the buying and selling of U.S. Treasury securities, for this control.

An important side effect of money supply control is control of interest rates. As the quantity of money changes, banks are willing to make loans at higher or lower interest rates.

Monetary policy comes in two basic varieties--expansionary and contractionary:

Expansionary monetary policy or easy money results if the Fed increases the money supply and lowers interest rates and is the recommended policy to counter a recession.

Contractionary monetary policy or tight money occurs if the Fed decreases the money supply and raises interest rates and is the recommended policy to reduce inflation.

Three Goals

The general goal of monetary policy is to keep the economy healthy and prosperous. More specifically, monetary policy seeks to achieve the macroeconomic goals of full employment, stability, and economic growth. That is, monetary policy is used to stabilize the business cycle and in so doing reduce unemployment and inflation, and the while promoting an environment that is conducive to an expanding economy.

A word about these three macroeconomic goals and associated problems is in order.

Full Employment: This results when all available resources (especially labor) willing and able to engage in production are producing goods and services. Falling short of this goal results in unemployment. Because some degree of unemployment naturally exists in a modern complex economy, full employment is achieved if the unemployment rate is about 5 percent. Unemployment means the economy forgoes the production goods and services.

Stability: This exists when fluctuations in prices, production, and employment have been eliminated. While stability for all aspects of the economy are important, monetary policy tends to be most concerned with price stability, that is, keeping the price level in check and eliminating inflation. Inflation erodes the purchasing power of financial wealth.

Economic Growth: This occurs when the production capacity of the economy increases over time, which is achieved by increasing the quantity and/or quality of resources. When the economy grows and production capacity expands, then more goods and services are available to satisfy wants and needs. Without economic growth, the economy stagnates, and often even experiences a falling living standard.

FISCAL POLICY VS MONETARY POLICY

I. THE BUSINESS CYCLE

Market economies have regular fluctuations in the level of economic activity which we call the business cycle. It is convenient to think of the business cycle as having three phases. The first phase is expansion when the economy is growing along its long term trends in employment, output, and income. But at some point the economy will overheat, and suffer rising prices and interest rates, until it reaches a turning point -- a peak -- and turn downward into a recession (the second phase). Recessions are usually brief (six to nine months) and are marked by falling employment, output, income, prices, and interest rates. Most significantly, recessions are marked by rising unemployment. The economy will hit a bottom point -- a trough -- and rebound into a recovery (the third phase). The recovery will enjoy rising employment, output, and income while unemployment will fall. The recovery will gradually slow down as the economy once again assumes its long term growth trends, and the recovery will transform into an expansion.

II. ECONOMIC POLICY AND THE BUSINESS CYCLE

The approach to the business cycle depends upon the type of economic system. Under a communist system, there is no business cycle since all economic activities are controlled by the central planners. Indeed, this lack of a business cycle is often cited as an advantage of a command economy. Both socialist and fascist economies have a mix of market and command sectors. Again, the command sector in these economies will not have a business cycle -- while the market sector will display a cyclical activity. In a full market economy -- like the United States -- the nation can suffer extreme swings in the level of economic activity.

The economic policies used by the government to smooth out the extreme swings of the business cycle are called contracyclical or stabilization policies, and are based on the theories of John Maynard Keynes. Writing in 1936 (the Great Depression), Keynes argued that the business cycle was due to extreme swings in the total demand for goods and services. The total demand in an economy from households, business, and government is called aggregate demand. Contracyclical policy is increasing aggregate demand in recessions and decreasing aggregate demand in overheated expansions.

In a market economy (or market sector) the government has two types of economic policies to control aggregate demand -- fiscal policy and monetary policy. When these policies are used to stimulate the economy during a recession, it is said that the government is pursuing expansionary economic policies. And when they are used to contract the economy during an overheated expansion, it is said that the government is pursuing contractionary economic policies.

III. FISCAL POLICY AND MONETARY POLICY

Fiscal policy is changes in the taxing and spending of the federal government for purposes of expanding or contracting the level of aggregate demand. In a recession, an expansionary fiscal policy involves lowering taxes and increasing government spending. In an overheated expansion, a contractionary fiscal policy requires higher taxes and reduced spending. According to Keynes, a recession requires deficit spending while an overheated expansion requires a budget surplus.

1) Discretionary Fiscal Policy. The first way this can be done is through the federal budget process. However, this process takes so long -- 12 to 18 months -- that it is difficult to match discretionary fiscal policy with the business cycle. The expansionary Kennedy tax cut of 1964

and later the contractionary Ford tax increase of 1974 hit the economy just when the opposite contracyclical policy was needed. As a result, the federal government will only use discretionary fiscal policy in a severe recession, such as 1981-82 and 2008-09. In both cases, the federal government resorted to a large fiscal stimulus tax cuts in 1981-82 and increased spending in 2008-09. Both policies created large deficits, which is the appropriate stabilization policy during a severe downturn.

2) Automatic Stabilizers. A second type of fiscal policy is built into the structure of federal taxes and spending. This is referred to as "nondiscretionary fiscal policy" or more commonly as "automatic stabilizers". The progressive income tax (the major source of federal revenue) and the welfare system both act to increase aggregate demand in recessions, and to decrease aggregate demand in overheated expansions. These automatic changes in spending and taxes will generate a deficit in recessions and a surplus in overheated expansions. The size of these automatic changes can be quite large. In the 2008-09 recession the deficit stimulus due to the automatic stabilizers was much larger than the stimulus created by the legislative changes in taxes and spending (discretionary fiscal policy).

Monetary policy is under the control of the Federal Reserve System (our central bank) and is completely discretionary. It is the changes in interest rates and money supply to expand or contract aggregate demand. In a recession, the Fed will lower interest rates and increase the money supply. In an overheated expansion, the Fed will raise interest rates and decrease the money supply.

These decisions are made by the Federal Open Market Committee (FOMC) which meets every six to seven weeks. The policy changes can be done immediately, although the impact on

aggregate demand can take several months. Monetary policy has become the major form of discretionary contracyclical policy used by the federal government. A source of conflict is that the Fed is independent and is not under the direct control of either the President or the Congress. This independence of monetary policy is considered to be an important advantage compared to fiscal policy.

Note that expansionary monetary policy is commonly called "easy money" while contractionary monetary policy is called "tight money". Other terms are also used.

CONCLUSION
We have demonstrated that perfect capital mobility implies different concepts of stabilization policy from those to which we have become accustomed in the post-World War II period. Monetary policy has no impact on employment under fixed exchange rates, whereas fiscal policy has no effect on employment under flexible exchange rates. On the other hand, fiscal policy can have an effect on employment under fixed exchange rates whereas monetary policy has a strong effect on employment under flexible exchange rates. Another implication of the analysis is that monetary policy under fixed exchange rates becomes a device for altering the levels of reserves, whereas fiscal policy under flexible exchange rates becomes a device for altering the balance of trade, both policies leaving unaffected the level of output and employment. Under fixed exchange rates, open market operations by the central bank result in equal changes in the gold stock, open market purchases causing it to decline and open market sales causing it to increase. And under flexible exchange rates, budget deficits or surpluses induced by changes in taxes or government spending cause corresponding changes in the trade balance.

BIBLIOGRAPHY

http://www.investopedia.com/terms/s/stabilization-policy.asp http://www.columbia.edu/~ram15/ie/ie-18.html http://www.britannica.com/EBchecked/topic/240167/government-economicpolicy/26307/History-of-stabilization-policy http://www.preservearticles.com/201012291897/advantages-disadvantages-fixed-exchangerates.html http://www.econlib.org/library/Enc/FiscalPolicy.html http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=monetary+policy http://faculty.etsu.edu/hipples/fpvsmp.html