Question

Which of the following policy recommendations are consistent with the Keynesian, Monetarist, and/or Supply-Side views of the macroeconomy and stabilization policy? EXPLAIN CAREFULLY!

A. Since the long-run growth rate of real GDP is currently 2% per year, the Fed should set a target growth rate of the money supply at 2% per year.

B. Decrease government spending in order to reduce inflationary pressure.

C. Increase the money supply in order to alleviate a recessionary gap (i.e. a situation where current real GDP is below potential real GDP).

D. Support a balanced budget amendment.

E. Balance the federal budget over the course of the business cycle.

F. Practice functional finance each federal fiscal year.

Answer 1

A. Monetarist

It is a monetarist statement as the money supply needs to be controlled so as to control the inflation in the economy. A monetarist is an economist who holds the strong belief that the money supply, including physical currency, deposits and credit, is the primary factor affecting demand in an economy. Consequently, the economy's performance, its growth or contraction, can be regulated by changes in the money supply.

B. Keynesian

Contractionary Fiscal Policy

Contractionary fiscal policy is a form of fiscal policy that involves increasing taxes, decreasing government expenditures or both in order to fight inflationary pressures. Due to an increase in taxes, households have less disposal income to spend. Lower disposal income decreases consumption.

C Keynesian

This involves the government seeking to increase aggregate demand through higher government spending and/or lower tax.Expansionary fiscal policy is usually financed by increased government borrowing and selling bonds to the private sector.

Keynes said expansionary fiscal policy should be used during a recession when there is unemployment, surplus saving and falling real output. He argued this injection of government spending could stimulate economic activity and get the unemployed resources back into productive use. This enables the economy to recover more quickly than a laissez-faire approach.

D Supply Side Economics

The balanced budget amendment is a proposal for an amendment to the Constitution to limit government spending to the amount of money received in revenue. The federal government would have to control spending. One concern is national emergencies which might not be dealt with effectively if there was a requirement for a balanced budget.

Supply side economists argued that cutting taxes, especially those of high income groups, would increase government revenues, because lower tax rates would produce more incentives for business and individuals to work and less reason for them to avoid taxes whether through non-productive investments in tax shelters or outright tax avoidance. Cutting taxes would result in more jobs, a more productive economy, and more government revenues. These economists believe that with the application of supply side economics balanced budget can be achieved.