Fiscal and monetary policies are frequently used together to restore an economy to full employment output. For example, suppose an economy is experiencing a severe recession. One possible solution would be to engage in expansionary fiscal policy to increase aggregate demand. The central bank can also do its part by engaging in expansionary monetary policy.
On the other hand, we can’t assume that the government and the central bank will always see eye-to-eye on the economy, and it is possible that these two entities work against each other. For example, suppose a government wants to increase output and decrease unemployment by increasing government spending. If the economy is operating on an upward-sloping aggregate supply curve (in other words, if prices are sticky), then this is also going to lead to inflation.
Recall that most central banks operate under a dual mandate to encourage full employment and control inflation.
If the central bank believes that the unemployment rate is lower than the natural rate of unemployment and there is inflation, it might take action to counteract what the government is doing to control inflation. For example, if the government engages in expansionary fiscal policy that leads to inflation, the central bank might decrease the money supply to lower inflation.
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