Question

use the graphical tools, along with a “story.”

A. The federal government ran a budget surplus in the late 1990 and in the year 2000, but has since returned to running a budget deficit.

1. Explain why reducing the budget deficit can cause short-term pain in the form of lower employment, higher unemployment, and a recession.

2. Explain why expansionary monetary policy would help decrease the likelihood of a recession if it were adopted at the same time the budget deficit was being reduced.

Answer 1

1)In the developing countries like India and the other third world countries there are problem of unemployment arises.and the economy is in a vicious cycle of low income.to overcome the vicious cycle those counties needs huge amount of investment.but that huge investment is not possible due to lower savings of the individual.so there are lack of funds and there are unutilised resources.and also there are some industries like power plant,coal etc needs huge investments and the return from that will occurs after very long periods but those are essential for a country to develop and also important for other industries.so for all those things the government has to step up and spend more.but if the government try to reduce there fiscal deficit that means he has to lower the expenses in those sectors which directly affect the country's growth rate.the country's growth rate will fall and if it falls then investors will not attract to invest more in that country as in near future investors can't earn profit or interest as they expected.so the effect of reduction in budget deficit will slow down the all economic activity in the country.so, the recession will start.

The reduction of budget deficit has also impact on the employment level.if the budget deficit reduces then it means the trasfer payments from the government to the individuals will also reduce so the income of individuals also reduce.so the aggregate demand of the economy will fall and if the aggregate demand falls then firms has to reduce their production which may cause falls in the input levels aka. labour.so the demands for labour will also falls and may be people those are involved in works are now not getting any job so the level of unemployment will rise.and as the recession stats the level of employment will also falls.

2)now if the government wants to reduce budget deficit then has to cut his expences.now as the government cut down their expenses then the supply of money in the economy will reduces which can start a recession.but a expansionary monertay police can stop the recession.expansionary moneytary policy is increase the supply of money and it can be taken by the Central bank of any country.now suppose at the time of recession and reduction in budget deficit the Central bank lowers the rate of interest then it will now more profitable for investors to lend and invest it as now he has to pay less interest than before so his margin of profit will rise.and this is true for all investors and as they invest more the aggregate demand of the economy will rise and the country can overcome the situation of recession.

On the other hand the central bank can buy back bonds he sells to the inviduals and give them back money with certain interest.then also the money supply of the economy will rise.now the individuals has more money in hand to spend so the aggregate demand of the economy will rise which may rise the price of products and as product price will rise the firms will produce more using more inputs likely labour.so the employment level goes up.so in this way the country can overcome a situation of recession although the budget deficit of the country reduces