Question

Suppose you’ve been hired as an economic adviser for the United States government. The president has requested to meet with you so that he can brush up on his ECON 302 skills. As an economist, you know that the economy is currently going through a contraction on its business cycle, so you have predicted a list of questions the president is likely to ask. Here is the list of questions to address in your post:

1. Should we implement an expansionary fiscal policy or a contractionary fiscal policy?
2. Why would we implement this policy?
3. Under this policy, what’s something we could pass that would make the American people happy? Propose a specific idea, like a salary hike for all government economists.
4. What are the reasons why it might make sense to influence the economy through government policy?

Answer 1

Country is going through contractionary phase of business cycle where its current level of output is less than potential level of output.

1) We should adopt expansionary fiscal policy to combat recession.

2) This policy will help in raising aggregate demand in an economy which will vanish recessionary gap. Assume economy is producing Y0 level of output where Y1 is potential level of output. Expansionary fiscal policy will shift demand curve to its right and take economy to its potential level of output Y1.

3) Government can reduce tax level which will raise disposable income of consumers such that they can spend more money on goods. It will make everyone happy.

or

Government can pass some transfer payments to needy people such that they can afford a basic standard of life.

4) Government can raise unemployment benefit which will give sustainable income to people who lost their jobs due to contractionary phase, lower the rate of interest such that people do not save more money to earn rate of interest rather theyr spend money which will raise circulation of money in the economy.

5) We can say boosting economy through government policy is more effective than monetary policy because government can directly spend money on the sector which is lagging while we have to indirectly influence producers to invest in the market.