Transcript ECN 202: Principles of Macroeconomics Nusrat Jahan Lecture-2

ECN 202: Principles of Macroeconomics
Nusrat Jahan
Lecture-11
Fiscal Policy & Monetary Policy
What is Fiscal Policy?
Fiscal policy consists of deliberate changes in government spending and tax
collections designed to achieve full-employment, control inflation and encourage
economic growth.
Fiscal policy influences saving, investment, and growth in the long run.
In the short run, fiscal policy primarily affects the aggregate demand.
Fiscal policy includes
 Changes in Government Purchases
Changes in taxes
Fiscal Policy Choices:
Expansionary Fiscal Policy- When recession occurs expansionary fiscal
policy can be implemented to prevent economic downfall.
Contractionary fiscal policy- When demand-pull inflation occurs, a restrictive
or contractionary fiscal policy can be implemented to control it.
Expansionary Fiscal Policy
During recession investment↓ as a result AD curve shifts to the left.
Expansionary fiscal policy can be taken 3 waysoIncreased Government Spending (G)- An increase in government spending
shifts the AD to the right.
oTax reduction(T)- A decrease in taxes (raises income and consumption rises by
MPC times the change in income). AD shifts to the right.
oCombined Government spending increases and tax reductions
Contractionary Fiscal Policy
When demand-pull inflation occurs, the demand for goods & services ↑ as a
result investment↑ which shifts the AD curve rightwards.
Contractionary fiscal policy can be taken in 3 waysoDecreased government spending- A decrease in G shifts the AD curve back to
left.
oIncreased taxes- An increase in the tax will reduce income and thereby decrease
consumption which shifts the AD curve to the left.
oCombined government spending decreases and tax increases
Effects of Fiscal Policy
 There are two macroeconomic effects from the change in government purchases or
taxes:
The Multiplier Effect:
Each dollar spent by the government or cut in taxes can raise the aggregate demand
for goods and services by more than a dollar.
The multiplier effect refers to the additional shifts in aggregate demand that result
when expansionary fiscal policy increases income and thereby increases consumer
spending.
The formula for the multiplier is:
Multiplier = 1/(1 - MPC)
Price
level
AD’’
AD’
AD
GDP
The crowding-out effect:
Fiscal policy may not affect the economy as strongly as predicted by the
multiplier.
An expansionary fiscal policy creates budget deficit which causes the interest
rate to rise.
A higher interest rate reduces investment spending.
This reduction in demand that results when a fiscal expansion raises the interest
rate is called the crowding-out effect.
The crowding-out effect tends to dampen the effects of fiscal policy on
aggregate demand.
What is Monetary Policy
It consists of deliberate changes in the money supply to influence interest rates and thus
the total level of spending in the economy to achieve and maintain price-level stability,
full employment and economics growth.
Impacts of Monetary Policy on Aggregate Demand
 Expansionary Monetary Policy:
 Central bank lowers the interest rate
 This in turn stimulates investment which increases the quantity of
goods and services demanded at any given price level, shifting
aggregate-demand to the right.
 Contractionary Monetary Policy:
 Central bank raises the interest rate
 This dampens investment which reduces the quantity of goods and
services demanded at any given price level, shifting aggregatedemand to the left.