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When the economy faces a recession, how do central banks and governments team up to fix it?

The answer lies in the policy mix. A policy mix means using fiscal and monetary policies together to influence income, interest rates, and overall economic stability.

During a recession, expansionary fiscal policy, such as higher government spending or lower taxes, shifts the IS curve to the right. This raises planned expenditure and increases output at any given interest rate.

If the central bank simultaneously increases the money supply, the LM curve also shifts to the right, lowering interest rates and encouraging more borrowing and spending. This combination strengthens recovery and forms a supportive policy mix.

But if the government increases spending while the central bank tightens monetary policy, the IS curve shifts right and the LM curve shifts left. In this case, rising interest rates make borrowing costlier for businesses and households, which weakens the economic recovery.

An optimal policy mix combines accommodative monetary policy with expansionary fiscal policy. Understanding the policy mix helps governments and central banks support sustainable economic growth.