Q. A naïve implication of the DD - AA framework is that either fiscal or monetary policy can lead to full employment. Discuss why this view is naïve.

Answer:

1. Inflation may occur without any gain in output if the government misuses its power to print money.

2. In practice it is occasionally hard to be sure whether a disturbance to the economy originates in the output or assets markets.

3. Shifts in financial policy often can be made only after lengthy legislative deliberations. Governments are probable to respond to disturbances by changing the monetary policy even when a shift in fiscal policy would be more appropriate.

4. Financial policy impacts the government budget and may lead to a government budget deficit that must sooner or later be closed by a fiscal reversal. The affirm of the electoral cycle may be more important.

5. Policies operate in realism with lags of varying length.