Question

Explain graphically and in words how fiscal and monetary policy affect the macro economy, and under what conditions this intervention may be desired.

1. If congress expects a recession next year, what steps can it take to try to prevent it? Explain how such a policy could achieve the desired goal. Illustrate your answer with an appropriate graph

2. If the fed(central bank) is concerned that the economy is overheating and fears that inflation may result, what steps can it take to try to prevent it? Explain how such policy could achieve desired goal. Illustrate your answer with an appropriate graph

Answer 1

Sol :

Fiscal and Monetary Policy effects the amcro economy either to increase the aggregate demand (Deflation ) or decrease it.( Inflation)

This intervention is necessary when there is a inflation ( increase in price level ) or deflation ( Decrease in price level ) in the economy .

Diagram will be as follows :

1 : If congress expects recession next year , then it must follows the follwoing two policies as follows :

•       Fiscal Policy : Increase in Government Spending and Decrease in Taxes .
•       Monetary Policy : Decrease in reserve requirement rate ; Buying of bonds in the open market operation ; Decrease in interest rate.

[ As, all of the above policies helps in increasing the aggregate demand in the economy. Also, this will increase in the money supply in the economy. Due ot increase in money supply , people will demand for more good. this will increases the consumption in the eocnomy and due to which AD move towards the rightward ( i.e Intiall full employment level) ]

Diagram :

2 : If , the Fed concerned that economy is overheating means economy is in inflation . so in order to reduce the inflation following policies should be taken :

• Fiscal Policy : Decrease in Government Spending and increase in Taxes .
•       Monetary Policy : Increase in reserve requirement rate ; Selling of bonds in the open market operation ; Increase in interest rate.

• [ As, all of the above policies helps in Decreasing the aggregate demand in the economy. Also, this will decrease in the money supply in the economy. Due ot Decrease in money supply , people will demand for less good. this will decreases the consumption in the economy and due to which AD move towards the leftward ( i.e Initial full employment level) ]

Diagram :