[BU204M5] Assessment Template
In this Assessment, your role will be of an assistant researcher in economics. Your job is analyzing the consequences of the changes in fiscal and monetary policy instruments that may be associated with the variations in the U.S. economic conditions. With this in mind, address the following on the effects of monetary and fiscal policies on the aggregate demand (AD) and short run macroeconomic fluctuations that lead to the recessionary gap and inflationary pressure in the U.S. economy.
There are three parts to this Assessment. This Assessment requires a combination of short paragraph answers, computations, and completion of a 450–500 word essay.
One of the main roles of the government is stabilizing the economy to attain macroeconomic goals such as price-level stability, full employment, and economic growth. Macroeconomic fluctuations may occur due to shifts in the aggregate demand (AD) or shifts in the short-run aggregate supply curve (SRAS) (See Figure 1). Therefore, policymakers every so often strive to counte
alance these AD and AS curve shifts by using monetary policy and fiscal policy instruments in an attempt to reach long-run equili
ium by closing the recessionary and the inflationary gaps.
Figure 1
Part I: Fiscal Policy
The government utilizes fiscal policy instruments (tools) to stabilize the economy and to achieve full employment, control inflation, and encourage economic growth. Fiscal policy is planned adjustments in the government spending and taxes. This part introduces you to the use of fiscal policy instruments to deal with the two major economic problems of recession (unemployment) and inflation. With this background information, answer the following questions on the uses and the effects of the fiscal policy tools to deal with the recessionary and the inflationary gaps.
Section 1: Fiscal Policy and the Recessionary Gap
Suppose that the U.S. economy is operating below full-employment equili
ium due to the recessionary gap with high rate of unemployment, and the equili
ium point between AD and SRAS occurs below potential real GDP (See Figure 2). Cognizant of the government plan, answer the following questions on the use of fiscal policy tools during the recessionary gap.
Figure 2
a) What is the type of fiscal policy the government uses to close the recessionary gap?
The government uses an expansionary fiscal policy to close the recessionary gap (Krugman & Wells, 2018).
) What are the fiscal policy instruments available to the policy makers and how would they be used? Explain.
Expansionary fiscal policies can take the form of lower taxes or higher government expenditure. Both of these increases the aggregate demand and in turn, stimulates the aggregate level of production (Krugman & Wells, 2018).
c) What are the effects of each of the fiscal policy instruments designed to fight recessions on the Federal Budget and the national debt?
With the expansionary fiscal policies, the federal budget deficit which is given by Taxes less government expenditure will increase. Federal budget deficit need not be bad for the economy if the deficit occurs due to government investment in productive activities. National Debt is money owed by the government at a particular point in time. since it takes into account all the federal deficits, National Debt will also increase (Krugman & Wells, 2018).
Section 2: Fiscal Policy and the Inflationary Gap
Suppose the U.S. economy is operating above full-employment equili
ium, which leads to significantly high demand-pull inflationary pressure (see Figure 3). The government plans to use the fiscal policy instruments to close the inflationary gap by shifting the aggregate demand curve. Mindful of this government strategy, answer the following questions on the use of fiscal policy tools during the inflationary gap.
a) What is the type of fiscal policy the government uses to close the inflationary gap?
Contractionary fiscal policy is designed to close an inflationary gap by changing aggregate expenditures and shifting the aggregate demand curve. The inflationary gap can be closed with contractionary fiscal policy basically a decrease in government purchases, an increase in taxes, or a decrease in transfer payments (Krugman & Wells, 2018).
) What are the fiscal policy instruments available to the policy makers and how would they be used? Explain.
There is an inflationary pressure which means that the aggregate demand is higher than the potential output level. When the government uses the fiscal policy to control the situation, it would be targeting to lower the aggregate demand for which it will follow contractionary fiscal policy and in this case, use the following fiscal policy instruments decrease government expenditure and increase the taxes which would decrease the consumption and investment and thus it would decrease aggregate demand and the curve will shift to the left to the potential level (Krugman & Wells, 2018).
c) What are the effects of each of the fiscal policy instruments designed to fight inflation on the Federal Budget and the national debt?
The instruments of fiscal policy are government spending and tax rate. If tax rate increase or government spending decrease then the aggregate demand decrease. As a result, the AD curve shift to leftward. Here the economy faces the inflationary gap situation (Krugman & Wells, 2018).
This means that the actual real GDP is higher than the potential GDP. Now to attain the potential GDP if the government use the fiscal policy instrument then the government have to increase the tax rate or decrease the government spending (Krugman & Wells, XXXXXXXXXXIncreasing tax rate or decreasing government spending lead to shift the AD curve to leftward. As a result, the economy will reach at full employment equili
ium (Krugman & Wells, XXXXXXXXXXWhen tax rate increase or government spending decrease then the national debt and Federal Budget deficit decrease. Because increasing tax rate increase the government revenue and decreasing government spending also increase the government revenue. When government revenue increase and government spending decrease then the nation face a surplus situation. In case of national surplus situation, the national debt decrease, and it also reduce the Federal Budget deficit. This means that the increasing tax rate and decreasing government spending reduce the Federal Budget deficit and it also reduce the national debt (Krugman & Wells, 2018).
Figure 3
Part II: Monetary Policy
The Federal Reserve System uses monetary policy that involves making planned changes in the money supply to manipulate interest rates to alter the total level of spending in the economy. The policy goals are achieving price-level stability, full employment, and economic growth. Based on this information, answer the following questions on how the Federal Reserve System applies the monetary policy tools to deal with the recessionary and inflationary gaps.
Section 1: Monetary Policy and the Inflationary Gap
Suppose the U.S. economy is operating above the full-employment equili
ium due to an overspending in the economy with significantly high inflation rates (see Figure 4). The Federal Reserve wants to design policy plans to reduce the high rate of inflation without causing a recession. Based on this underlying assumption, answer the following questions.
Figure 4
a) What is the type of monetary policy the Federal Reserve System can undertake to address the inflationary problem?
To control inflation, the Federal Reserve System must use contractionary monetary policy to slow economic growth. The Federal Reserve System actions reduce the liquidity in the financial system, making it becomes more expensive to get loans. It slows economic growth and demand, which puts downward pressure on prices (Krugman & Wells, 2018).
) What are the instruments of monetary policy that the Federal Reserve System uses to close the inflationary gap? Explain.
When the economy is in an inflationary gap, the Federal Reserve System will adopt a contractionary monetary policy to decrease the money supply in the market by selling securities, raising the reserve rate, and/or increasing the discount rate. Also, the Federal Reserve’s three instruments of monetary policy are open market operations, the discount rate and reserve requirements (Krugman & Wells, 2018).Open market operations involve the buying and selling of government securities. The term open market means that the Federal Reserve doesn’t decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an open market in which the various securities dealers that the Federal Reserve does business with the primary dealers compete on the basis of price (Krugman & Wells, XXXXXXXXXXOpen market operations are flexible, and thus, the most frequently used tool of monetary policy. The discount rate is the interest rate charged by Federal Reserve Banks to depository institutions on short-term loans. Reserve requirements are the portions of deposits that banks must maintain either in their vaults or on deposit at a Federal Reserve Bank (Krugman & Wells, 2018).
c) How does management of its money supply enable the Federal Reserve to manage the economy in order to reduce inflationary pressure?
The primary job of the Federal Reserve is to control inflation while avoiding a recession. It does this with monetary policy. The Federal Reserve reduces liquidity in the financial system, making it more expensive to get loans (Krugman & Wells, XXXXXXXXXXIt slows economic growth and demand, which puts downward pressure on prices and helps to manage the economy in order to reduce inflationary pressure (Krugman & Wells, 2018).
Section 2: Monetary Policy and the Recessionary Gap
Assume the U.S. economy is in a recession operating below potential output (the real GDP) and the Federal Reserve System takes appropriate monetary policy actions to close the recessionary gap (see Figure 5). Anchored in this essential statement, answer the following questions on how the monetary policy tools are used to deal with the recessionary gaps.
Figure 5
a) What is the type of monetary policy the Federal Reserve System utilizes in an attempt to close the recessionary gap?
When the economy is in a recessionary gap, the Federal Reserve will adopt expansionary monetary policy to increase money supply in the market by buying securities, lowering the reserve rate, and decreasing the discount rate (Krugman & Wells, 2018).
) What are the instruments of monetary policy that the Federal Reserve System uses to close the recessionary gap? Explain.
The Federal Reserve’s three instruments of monetary policy are open market operations, the discount rate and reserve requirements. To implement a close in a recessionary gap a stabilization policy help to close the gap and it increases the real GDP, which is called an expansionary policy (Krugman & Wells, XXXXXXXXXXThe monetary authority may increase the amount of money in circulation in the economy by lowering interest rates and increasing government spending to help close the recessionary gap (Krugman & Wells, 2018).
c) How does management of its money supply enable the Federal Reserve to manage the economy in order to reduce recessionary pressure?
The management of money supply is aimed at controlling and reducing recessionary pressure. This is achieved by modifying interest rates, buying or selling government bonds, regulating foreign exchange rates, and changing the amount of money banks are required to maintain as reserves (Krugman & Wells, 2018).
Part III: Fiscal and Monetary Policy Applications
Compose the following in a 450–500 word essay. Now that you have segmented the components on how fiscal and monetary policies can