Explain how fiscal policy (government spending and taxes) and monetary policy (determining interest rates) affect the...
Explain how fiscal policy
(government spending and taxes) and monetary policy (determining
interest rates) affect the level of output and employment in the
economy according to Keynesian theory. What fiscal and monetary
policies should the government follow to pull the economy out of a
recession?
Homework Answers
Fiscal policy: Government purchases are part of the aggregate demand in the economy, a higher government purchase will lead to a higher demand and that will increase the output and employment in the market. On the contrary, a higher tax will reduce the disposable income and that will lead to a fall in the demand which will increase the unemployment and reduce the output.
Monetary policy will have similar effects in the market, a tighter monetary policy i.e. a increase interest rate will decease the aggregate demand and increase the saving that will lead to unemployment and low output and vice versa.
To pull the economy out of a recession the firm in the government will increase the government purchase and decrease the taxes and we will have to adopt a easy monetary policy.
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Explain how fiscal policy
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