Question

Consumer and investor optimism and pessimism matter a great deal in the economy. Suppose that survey measures of consumer confidence indicate a wave of pessimism is sweeping the country. If policymakers do nothing, what will happen to aggregate demand? What should the Federal Reserve do if it wants to stabilize aggregate demand? If the Federal Reserve does nothing, what do you think might Congress (fiscal policy) do to stabilize aggregate demand? Why do you think consumer and investor confidence affect AD and hence the economy?

One of the most debated areas in economics is balancing the budget. The major contention is on the timing of the policy. If the government were to operate under a strict balanced-budget rule, what do you think would it have to do in a recession? Should it follow the strict rule? Would that make the recession more or less severe? Why?

Answer 1

In case consumer confidence falls across the country then this will mean there will be a fall in consumption, investment and export levels in the country. Thus if consumer confidence falls then over time the aggregate demand falls. In such a situation the best way for the Federal Reserve is to use a expansionery monetary policy through a reduction in interest rates or an open market purchase of bonds to increase the money supply and boost spending. In case monetary policy remains same and the Fed does nothing then the Congress can use a expansionery fiscal policy through a cut in taxes or an increase in government spending. Consumer and investor confidence effect individual components of aggregate demand such as investment and consumption and hence this effects aggregate demand. In order to balance the budget the goverment will have bring about a cut in taxes ain order to balance the budget reduce government spending in the economy.This may worsen the recession in the short term but as the disaposable income rises the spending will recover and so the budget will be balanced.