Question

Short-run effects of economic policies - Colombia

4. Still using this discussion board, discuss with your group the pros and cons of performing the following policies once the crisis hits the country. Focus only on short-run effects!
   • Contractionary fiscal policy combined with expansionary monetary.
   • Expansionary fiscal policy and expansionary monetary policy

4. Please write two paragraphs report on which of the two policies would be better for the country you studied.

Answer 1

With the first policy, the IS curve representing the goods market will shift to the left from IS1 to IS2 while the LM curve representing the money market will shift down from LM1 to LM2. As a result in the short run, the improvement in crisis will take place and the economy will return to the long run level of output (Yf). The second policy shifts the IS curve to the right and LM curve downwards. As a result the IS shifts to IS2 and LM to LM2. The new equilibrium occurs at E2 where the economy reaches the full employment level of output(Yf).

The first policy is a better option since while correcting the crisis, it reduces the interest rate and makes the economy more stable. At lower interest rate, the demand for investment and private consumption is stable. While with a high interest rate the opportunity cost of borrowing increases both for the investors and private consumers. The increased opportunity cost may lead to a fall in investment and may result in pushing the economy into a crisis, again.