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?

Answer 1

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 it will decrease the aggregate demand. When there is a decrease in aggregate demand the production will also decrease resulting in the higher unemployment rate in the economy.

To stabilize the aggregate demand the Federal Reserve should adopt a policy which will increase in aggregate demand i.e the Federal Reserve increases the money supply in this case to increase the aggregate demand. Increase in money supply will decrease the interest rate and will encourage investment spending which increases aggregate demand.

If Federal Reserve does nothing, so to increase the aggregate demand the Congress(fiscal policy) should cut the tax rate so that the money in the hands of the people will increase and it will increase the aggregate demand.

As we know that consumer confidence measures how confident consumers are about the overall state of the economy and their income stability. Their confidence impacts their economic decisions—like their spending activity. So when it affects the spending activity it can go in both the ways i.e an increase in spending will increase the aggregate demand and a decrease in spending will decrease the aggregate demand.  At the same time investor confidence measure their willingness to the investment opportunity. So when they increase/decrease the investment based on confidence it will affect the aggregate demand.