(1) Choose a FISCAL policy that you would recommend to help an economy that is i
ID: 1227309 • Letter: #
Question
(1) Choose a FISCAL policy that you would recommend to help an economy that is in a recession. You should not choose a monetary policy (i.e. interest rate manipulation, selling of bonds, or printing of money). (2) Explain how your policy would help increase aggregate demand. That is, does it increase C, I, G, or X? (3) Explain what would happen to prices (i.e. inflation). You may use either the Modern Keynesian model or the Classical Model to conduct your analysis. Just be sure to note which one you are using.
Explanation / Answer
1.
Fiscal policy is an instrument of government by which economy of the country could be improved. Tax-rate adjustment is an example of such policy. Recession means shortage of money in the market. Development activities of the country could be stopped because of recession. The government can decrease the rate of tax for improving this situation.
2.
Aggregate demand (AD) = (C – tax) + I + G + X
Decreasing tax helps people to spend more, since their burden of paying high amount for tax is gone. Spending more means increasing consumption (C). Therefore, it helps to increase the aggregate demand.
3.
Increasing spending creates inflation, since the supply of goods and services is restricted in the short-run. People would like to pay more for satisfying their demands. It pushes price up.
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