BU204M5: Analyze how monetary and fiscal policy instruments are used to achieve macroeconomic goals.

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 counterbalance these AD and AS curve shifts by using monetary policy and fiscal policy instruments in an attempt to reach long-run equilibrium by closing the recessionary and the inflationary gaps.

Figure 1

Directions

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.

Before beginning this Assessment, view the following videos:
•Chapter 20: “Please Explain the Model of Aggregate Demand and Aggregate Supply.”
•Chapter 21: “If It’s Better to have Higher Output and Lower Unemployment, then Why Doesn’t the Government Use Monetary and Fiscal Policy to Expand Aggregate Demand as Much as Possible?”

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 equilibrium due to the recessionary gap with high rate of unemployment, and the equilibrium 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 in order to produce at the potential real GDP and reduce the high unemployment rate?

b) What are the two fiscal policy instruments available to the policymakers in this respect? Explain.

c) What are the impacts of such policy measures on the AD curve, real GDP and the employment level? Analyze the impact of each fiscal policy tool on the macroeconomic variables.

d) What are the effects of the fiscal policy instruments designed to fight recessions on the Federal Budget and the national debt? Evaluate the influence of each of the fiscal policy tools.

Section 2: Fiscal Policy and the Inflationary Gap

Suppose the U.S. economy is operating above full-employment equilibrium, 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?

b) What are the two fiscal policy instruments available to the policy makers in this respect?

c) What are the effects of these policy actions on the AD curve, price level and the real GDP? Analyze the effect of each policy tool on these macroeconomic variables.

d) What are the four methods the government can use to balance the budget? Examine each of the methods.

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 equilibrium due to an overspending in the economy with significantly high inflation rates (see Figure 4). The Federal Reserve want 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?

b) What are the three instruments of monetary policy that the Federal Reserve System uses to close the inflationary gap? Explain.

c) How does management of its money supply enable the Federal Reserve to manage the economy in order to reduce inflationary pressure? Evaluate its effectiveness.

d) What are the impacts of such monetary policy measures on the AD curve, price level and the real GDP? Analyze the effect of each tool on these economic variables.

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?

b) How does the Fed use each of the three monetary policy instruments to close the recessionary gap? Explain.

c) How will the consumption spending, investment spending and the real GDP be affected? Analyze the effects of each policy tool on these macroeconomic variables.

d) How does the Federal Reserve System determine the Federal Funds Rate and discount rate during the recessionary and the inflationary gaps? Explore the determination of the rates under the two economic conditions.

Part III: Fiscal and Monetary Policy Applications

Now that you have segmented the components on how fiscal and monetary policies can create recessionary and inflationary gaps, as an assistant researcher in economics, you must analyze how the consequences of the changes in fiscal and monetary policy instruments may be associated with the variations in the U.S. economic conditions. Provide examples based on your answers above to explain these consequences during a recession, and during inflationary times. 

Review how you will be graded in the Checklist Rubric here. 

Minimum Submission Requirements

•This Assessment should be in a separate Microsoft Word document. Use this template for your Assessment.
•Respond to the questions in a thorough manner, providing specific examples of concepts, topics, definitions, and other elements asked for in the questions. Your paper should be highly organized, logical, and focused.
•Your paper must be written in Standard English and demonstrate exceptional content, organization, style, grammar, and mechanics.
•Your paper should provide a clearly established and sustained viewpoint and purpose.
•Your writing should be well ordered, logical and unified, as well as original and insightful.
•A separate page at the end of your paper should contain a list of references, in APA format. Use your textbook, the Library, and the internet for research.
•Be sure to cite both in-text and reference list citations were appropriate and reference all sources. Your sources and content should follow proper APA citation style. Review the APA formatting and citation style found in the Writing Center. The Writing Center can be found within the Academic Support Center under Academic Tools in the left navigation of your course. (It should be in Times New Roman 12-point font, include correct citations, Standard English with no spelling or punctuation errors, and correct references at the bottom of the last page.)