Stabilization Policy Assume the US has a GDP equal to $18.2 trillion. The GDP ha

Question

Stabilization Policy

Assume the US has a GDP equal to $18.2 trillion. The GDP has been growing at 0.4% for the last two years. Unemployment in the nation is at 7.8% which is up from 4.8% three years ago. Inflation has been falling for the last two years and now stands at 0.5%. EXPLAIN IN DETAIL the problem(s) the nation is facing.

EXPLAIN IN DETAIL an active fiscal policy that could be used to solve the problem you identified in “a.” Be sure to include an explanation of the policy tools that should be used.

Explanation / Answer

GDP is currently is slightly lower than its potential level and similarly inflation is also lower than the target one. And similarly inflation is also lower than the target one unemployment rate is more than what is expected to be at its natural rate which is around 5%. This particular case describes recessionary gap in which output gap is negative and actual inflation is lower than the expected inflation. An active stabilization policy would be an expansionary fiscal policy. Government can use taxes, transfers or government spending to stimulate the aggregate demand and to shift it rightwards. This will increase the GDP and inflation rate and will bring the economy back to its original full employment level.

Government spending should be increased taxes should be decreased or the transfer income should be increased to stimulate the aggregate demand. Government is currently suffering from high fiscal deficit and budget deficit so it should use its stabilization policy of Fiscal expansion judiciously.

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