Monetary + Fiscal Policy Flashcards
Where do you find LR Equilibrium in the economy?
Natural Rate of Output
In LR- why does AD = SRAS as well?
Expected Prices = Actual Prices
- Expectations adjust to Actual levels
What are the main causes for Demand driven Fluctuations?
- Pessimism
- Stock Market bust
- Fall in Exports- Recession Abroad
- Monetary Contraction- e.g. Disinflation
What is the Result of a Demand driven Recession?
Decreased Y
Decreased Price Level
What happens to SRAS over time?
Shifts to RIGHT
- Y Increases back to NRO + Price Level Falls further
Decreased AD ——> Increased SRAS
What are the main causes of Supply driven Fluctuations?
- Sudden Increase in CoPs
- Increased Price Expectations
What is the Result of a AS driven Recession?
Decreased Y
Increased Price Level
— STAGFLATION
In response to a LEFT Shift in SRAS–> Stagflation, what can policy makers do to immediately correct the issue + what is the cost of the policy?
Increase AD
- BUT–> Inflation
How can Monetary Policy be used to Increase AD?
Increase M.S –> Decreased I.R at each PL –> Increase AD –> Increased Y + Increased PL
How can Monetary Policy be used to Decrease AD?
Decrease M.S –> Increased I.R at each PL –> Decrease AD –> Decreased Y + Decreased PL
What are the 2 main Monetary Policy tools used by C.Bs?
- Discount Rate
- Open Market Operations
Changing M.S –> changes I.R –> Changes AD
What is Fiscal Policy?
Changes in Gov. Spending +/ Taxes
- Directly Shifts AD
What is the Size of Impact of Fiscal Policy affected by?
- Multiplier Effect- Amplifies effect
- Crowding-out effect- Diminishes effect
How does the Multiplier Effect affect AD?
Shifts AD further to RIGHT beyond the Initial Shift
What does the Size of the Spending Multiplier depend on?
Depends on MPC
How does MPC affect Multiplier?
Higher MPC ––> Higher Multiplier
How is the Multiplier effect caused?
Increased C + I –> Increased Jobs –> Increased Income –> Higher C –> Increased Profitability –> Increased I –> Increased AD –> etc.
What is MPC?
Marginal Propensity to Consume
- Fraction of additional income spent on Consumption
What is the Multiplier equation?
m = 1 ÷ ( 1 - MPC )
How does the Crowding Out Effect affect AD?
Shifts AD back to LEFT slightly
_ Partially Offsets initial Increase in AD
How is Crowding out effect caused?
Increased AD –> Increased Income –> Increased M.D –> Higher I.R –> Decreased Investment –> Lower AD
What does the Actual effect of Fiscal Policy on AD depend on?
Depends on Size of Multiplier Effect RELATIVE to Size of Crowding Out Effect
What is Active Stabilisation Policy?
Use Fiscal Policy + Monetary Policy to Stabilise economy in shocks + waves of Optimism & Pessimism (Animal Spirits)
What is the Objective of Active Stabilisation Policy?
Ensure Full-employment + Stable Inflation
What does Keynesians say about Policy for Stabilisation?
Stress the key role of AD in explaining SR Fluctuations
- Gov. should actively stimulate AD
- To maintain Full Employment
What is the Case AGAINST Active Stabilisation Policy?
- AD difficult to control- due to Time Lags
- Policy must be based on unreliable economic forecasts
THEREFORE- Better to leave Economy alone- Let Market Mechanisms deal with SR Fluctuations - Instead use Policy for LR goals
What are Automatic Stabilisers?
Automatic changes in Spending that stimulate AD when Economy goes into Recession
What are the 2 main Automatic Stabilisers that Reduce the impact of a Recession?
- Decreased Taxes –> Increased C + I –> Increased AD –> Increased Y + PL
- Increased Unemployment Benefits –> Increased C –> Increased AD –> Increased Y + PL
Opposite in a BOOM
What are the Limitations of Automatic Stabilisers?
- Not strong enough to prevent Business-cycles completely
- Strength depends on Public Sector size relative to GDP
BUT- without Automatic Stabilisers- Output + Employment more Volatile
