Suppose an economy is experiencing a recessionary gap, !. Describe the state of

Question

Suppose an economy is experiencing a recessionary gap, !. Describe the state of the economy (what is a recessionary gap; describe the unemployment rate in relation to actual and potential GDP; what are the pressures on inflation) 2. Devise a recommended mixture of fiscal and monetary policies to reduce the gap. Technically, utilize 2 fiscal policy tools and the 4 monetary policy tools, what should be done to reduce the gap. 3.Describe the impact each of these would have on the components of PAE (how will these tools impact C, I, G, and net X?) 4. Thoroughly describe the advantages and disadvantages of each of the proposals. (ex. time required, long term ramifications, political complexities-- you might want to google " advantages of______policy")

Explanation / Answer

1) Recessionary gap is a situation wherein the real GDP is lower than the potential GDP at the full employment level. The economy operates below the full employment level in a recessionary gap.

According to Okun's Law, for every 1% increase in the unemployment rate, a country's actual GDP will be roughly an additional 2% lower than its potential GDP.

During recession the impact on inflation :

2) When an economy is in recession, expansionary fiscal policy and expansionary monetary policy are recommended which results in increased government spending or lower taxes, boost equilibrium output and return people to work.

The Tools which a government can use:

Fiscal policy tools:

Monetary policy tools:

3) Aggregate demand measures the demand for an economy's GDP. This value is calculated by the equation

AD= C + I + G + NX

Expansionary fiscal policy usually enacted in response to recessions, increases government spending. According to Keynesian economics, these programs prevent a negative shift in aggregate demand by stabilizing employment.

Expansionary monetary policy entails a Central bank either buying Treasury notes, decreasing interest rates on loans to banks or reducing reserve requirement.

All of these actions increase the money supply and lower interest rates.

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