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Econ Reading 7 - Congress and issue of what government...

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Econ103 – Macroeconomic Principles - Fall 2010 – Prof. Werner Baer reading 7- p.1 Reading 7: Effectiveness of Fiscal vs. Monetary Policy SUMMARY DURING RECESSION (low GDP, low inflation, high unemployment) DURING INFLATION (high GDP, high inflation, low unemployment) FISCAL POLICY (slow implementation, due to the slow political process) decrease T, increase G effective increase T, decrease G hard to implement because it is politically opposed by most people MONETARY POLICY (fast implementation) increase Money Supply not very effective, since consumers and investors do not respond much to interest rates when things are uncertain decrease Money Supply effective because it affects price: square4 it increases the interest rate, which decreases Aggregate Demand, and then prices; square4 it may reduce the pressure on prices directly – recall the exchange equation M*V=P*Q Fiscal policy: square4 Rigid (slow decision/implementation), because of political decision process (made by Executive and
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Unformatted text preview: Congress) and issue of what government expenditures or taxes to change. s More effective in the case of recessions, because it has quicker impact on aggregate demand Monetary policy: s Flexible (quick decision/implementation), because of technical decision process (made by the FED) s More effective in the case of inflation, because one of the causes of inflation is excess supply of money DEFINITIONS: s Budget deficit = Government expenditure – Tax revenues (if G>T) s Budget surplus = Tax revenues – Government expenditure (if G<T) What to do in a recession? s increase G and reduce T => create (larger) budget deficit s reduce interest rate (increase money supply) What to do in an inflationary period? s decrease G and increase T => create (larger) budget surplus s increase interest rate (decrease money supply)...
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