1. Explain the fiscal policy tools available to governments to alter macroeconom

Question

1. Explain the fiscal policy tools available to governments to alter macroeconomic activity. Your answer should include both depth and breadth and should include a discussion of the multiplier process and how that works through the economy. Include in your explanation how fiscal policy can be used to help correct a $1 Trillion recessionary gap assuming an MPC of 0.80.

2. Explain the Monetary policy tools available to governments to alter macroeconomic activity. Your answer should include both depth and breadth and should include a discussion of the monetary policy transmission mechanism and how that works through the economy. Include in your explanation how monetary policy can be used to help correct a $1 Trillion inflationary gap. General directions of change are sufficient and no specific calculations are required for this problem.

Explanation / Answer

Recessionary gap is the gap between the potential output and actual output.

Multiplier is the final change in national income due to change in autonomous expenditure.

Multiplier=1/1-mpc=1/1-0.8=5

Thus change in Y=multiplier*change in G

Thus change in G=1/5=0.2 trillion or it can also be done by decreasing tax.

Tax multiplier=-mpc/1-mpc=-4

Thus a decrease in tax of 0.25 trillion leads to increase in $1trillion.

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