Question

Application Activities:

1. Define fiscal policy and its key objectives. What government agencies are responsible for making decisions on fiscal policy actions and implementations?
2. Critically and briefly describe the following fiscal policy tools and their relative effectiveness in controlling business cycle fluctuations such as state of recession and/or state of inflation. How do they operate during recession and inflation? Draw AD-AS diagram of macroeconomics model to illustrate your explanation in words

• Government Spending
• Tax Policy

3. Define monetary policy and its key objectives. What government agency (s) is (are) responsible for making decisions on monetary policy actions and implementations?

Answer 1

1)

Fiscal policy refers to the change in tax and expenditure, which is aimed at changing direction of economy. Following are objectives of fiscal policy:

• Achieving higher level of growth.
• Achieving full employment objective.
• Providing stability to economic system.
• Achieving goals of equity and social justice.

Government has been entrusted with work to form and implement fiscal policy.

2)

Recession and fiscal policy:

Demand is deficient during the recession, hence government has to follow expansionary fiscal policies. it will shift Ad to right thereby increasing output and employment level. Following is diagram:

PL LRAS P2 P1 AD 2 AD 1 Real GDP (Y) Y1 Y2

In above diagram:

AD shift to right and output increases from Y1 to Y2. Expansionary fiscal policy helps to recover economy from recession.

Inflation and fiscal policy:

Government uses contractionary fiscal policy tackle problem of inflation. Tax is raised and expenditure is reduced to drive down aggregate demand, Following is diagram:

PL LRAS P1 P2 AD 1 AD 2 Real GDP (Y) Y2 Y1

Fall in the AD would reduce output and price level. Thus, inflation is controlled.

3)

Monetary policy refers to change in supply and cost of money in market. Objectives:

• Price stability.
• Full employments.

Federal Reserve is responsible for managing monetary policy. Usually, central bank of country manages monetary policy.