Question

Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap, explain：

1.How each theory would achieve those goals

2.How they would close the gap,

3.What's the potential negative effects.

According to monetary policy, explain：

1.how the Bank of Canada would react to a recession

2.how they would achieve those goals

3.how they would close the gap

4.what's the potential negative effects

Answer 1

1. A counter-cyclical fiscal policy means a policy or strategy by the government to counter boom or recession through fiscal measures. It works against the ongoing boom or recession trend For recession expansionary policy and during booms contractionary discal policy will be used.

Fiscal policy is a policy controlled by the government and it has two tools: taxes and govt. spending. During recessions govt. decreases taxes and increases govt. spending which is called expansionary fiscal policy. During inflation govt. increases taxes and decreases govt. spending which is called contractionary fiscal policy.

2. When taxes are low and government spend money then mu,tiplier effect comes into play and then gap between potential and actual employment is closed.

Similarly during booms taxes are increased and spending is reduced which leads to reduced aggregate demand.

3. There is always polcy conflict and less aggregate demand leads to unemployment and government has to spend more money on unemployment benefits. Similarly during booms price levels go up. Government budget also is compromised and money spent could have been spent on more asset building projects and human capital building.

Monetary policy:

1. Monetary policy is a policy determined by central bank and has two tools; interest rates and money supply. When there is inflation and central bank wants to reduce over consumption in an economy then it increases interest rates and decreases money supply. This is called as contractionary monetary policy. When there is recession and central bank wants to boost economic activity then it decreases interest rates and increases money supply. This is called as expansionary monetary policy.

2. Bank of Canada will use expansionary monetary policy to handle recession.

3. This policy will also act as expansionary policyto close output gaps but can be implemented sooner and interest rates drive economic changes faster.

4. Negative effects can be deflation or inflation in an economy, currency exchange rate change and also price competitiveness change in international markets.