Question

Explain the role of fiscal and monetary policy in an economy facing recession. Use appropriate graph to justify your answer

Answer 1

An economy facing recession sees drastic fall in aggregate demand leading to a fall in economic activities in the country which in turn leads to a higher unemployment.

We can see in the graph when aggregate demand curve AD has shifted to the left AD1, price level has also decraesed from P1 to P3. The real GDP during recession decreases from Y ( full equilibrium ) to Y ( recession ).

Fiscal and monetary policies can be used to revive aggregate demand in the economy thereby leading to an increase in economic activities in the economy which in turn increases real GDP in the economy.

An expansionary fiscal policy is use of economic policies such as a decrease in taxation or an increase in government spending to revive economic growth in the economy.

Likewise, an expansionary monetary policy is economic policy where use of either lower interest rate or an increase in money supply in the economy leads to a higher aggregate demand in the economy. The main component of this policy is increase in money supply in the economy which increases aggregate demand in the economy.