1/ Identify whether expansionary or contractionary fiscal policy, or no policy i
ID: 1152180 • Letter: 1
Question
1/ Identify whether expansionary or contractionary fiscal policy, or no policy intervention at all, would seem to be most appropriate in response to each of the situations below. Explain your answers
a. A stock market collapse that hurts consumer and business confidence.
b. Extremely rapid growth of exports.
c. Quickly rising inflation.
d. A decrease in the natural rate of unemployment.
e. A rapid rise in oil prices.
2/ Does it make more sense to debate the level of debt or the debt to GDP ratio? Explain
3/ True/False/Defend: The standardized employment budget deficit is more severe (has higher highs and lower lows) than the actual budget deficit over a business cycle.
4/ True/False/Defend: If the government gives a $300 tax cut to everyone in the country, then interest rates will rise.
5/ Use the investment=savings identity or the demand and supply of loanable funds equation to explain how each of the following might react to greater government budget deficits. Be sure to consider all possibilities.
a. Private saving
b. Investment
c. Savings by the rest of the world.
Explanation / Answer
(1)
(a) A stock market collapse will decrease aggregate demand and real GDP, and the economy will enter a recession. To pull the economy out of the recession, government has to increase aggregate demand using expansionary fiscal policy.
(b) Rapid growth of export will increase net exports, which will rapidly increase aggregate demand, increasing price level (causing inflation) and real GDP. To tame inflation, government has to decrease aggregate demand using contractionary fiscal policy.
(c) When inflation is rising fast, to tame inflation, government has to decrease aggregate demand using contractionary fiscal policy.
(d) Decrease in natural rate of unemployment will result from an increase in aggregate demand. This will lead to higher inflation, to tame which, government has to decrease aggregate demand using contractionary fiscal policy.
(e) Increase in oil price will increase input cost, making firms lower production and output. Aggregate supply will fall, leading to higher price level and lower real GDP, causing stagflation. If government wants to tame inflation, it will implement contractionary fiscal policy to lower aggregate demand and lower inflation. But if government wants to increase real GDP, it will implement expnsionary fiscal policy to increase aggregate demand, which will further increase inflation.
NOTE: As per Chegg Answering Policy, 1st question is answered.
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