Question

6. Using policy to stabilize the economy 

The government has the ability to influence the level of output in the short run using monetary and fiscal policy. There is some disagreement as to whether the government should attempt to stabilize the economy.

 

Which of the following are arguments in favor of active stabilization policy by the government? Check all that apply. 

• The Fed can effectively respond to excessive pessimism by expanding the money supply and lowering interest rates. 

• Businesses make investment plans many months in advance 

• The current tax system acts as an automatic stabilizer 

• Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses. 

Which of the following are examples of automatic stabilizers? Check all that apply 

• Corporate income taxes 

• The discount rate 

• Unemployment insurance benefits

Answer 1

The following are arguments in favor of active stabilization policy:-

-The Fed can effectively respond to excessive pessimism by expanding the money supply and lowering interest rates

-Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses.

The following are an example of automatic stabilizers:-

-Corporate income taxes

-Unemployment insurance benefits

Answer 2

Part one answers are options 2 and option 3 Part two answer is option 1

Answer 3

Those shifts in aggregate demand resulting from waves of pessimism lead to economic downturns in the economy. These downturns are not due to structural changes in the economy and are not beneficial. They exert unnecessary pressure on the economy. Similarly, shifts in aggregate demand resulting from waves of consumer and business optimism are also burdensome and bring about instability. To make the economy more stable, active stabilization policy tools that mitigate pessimism and optimism waves are advocated.

The waves of pessimism amongst consumers and businesses lead to falling in aggregate demand. This fall in aggregate can be partially or fully offset by increasing money supply because the increase in money supply boosts aggregate demand.

Therefore, for the first question, options A and B apply.

When the economy goes into recession, unemployment increases and their unemployment allowances were given by the government increase. Owing to unemployment insurance, government spending automatically increases when the economy falls into recession. Similarly, recession only reduces personal taxes, which is an automatic boost to aggregate demand in the event of a recession. Therefore, for the second question, check the first two options.