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Question:Consider the following statement “The Australian economy is "weak", with households weighed down by slow wages...

Question:Consider the following statement “The Australian economy is "weak", with households weighed down by slow wages growth and higher taxes, the OECD has declared in a report that backs lower interest rates, calls for more government spending and paves the way for unconventional monetary policies.” Use the dynamic AD-AS model to describe a longer run scenario where the government is trying to pursue higher economic growth using higher government spending, but were incorrect in their estimation of the major parameters governing long run full employment equilibrium. In your analysis discuss the implications of an incorrect scenario predicted by the government when effecting their stimulus policy on equilibrium output and (un)employment. Make sure to outline the assumptions you have made to reach your conclusion.

（word limit:400-500）

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Expert Solution

As it is suggested an expansionary fiscal policy by increasing government spending and a tax cut, leading to an increase in the disposable income of the people, which in turn lead to increase in aggregate demand,more investment.more employment and more output and economic growth.

Whether for good or for ill,the ability of the fiscal policy to influence the level of ouput by increasing aggregate demand wears out in the long run.Higher aggregate demand through fiscal stimulus shows up only in higher prices i.e. an ever accelerating inflation,and does not increase output because in the long run level of output is affected by the supply of factors of production and not by aggregate demand. The policy measures can only cause short term fluctuatins in the naturai rate of growth of factors of production.

Ironically the long run effects of fiscal expansion tend to be the opposite of the short run effects,for the increased government expenditure means increased government debts or reduction in government saving(budgatery surplus) which in future lead to decrease in investment,more burden of taxes for the people,less output and employment.

The suggestion is the adoption of counter cyclical fiscal policy to stabilize the economy rather than the long term policies.

Rahul Sunny answered 2 months ago
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