Answer to Question #111424 in Macroeconomics for Kwezi

Question

Use the AD-AS model to illustrate and explain how the authorities can use monetary and fiscal policies stimulate economic growth.

Answer 1

Monetary policy:

An expansionary monetary policy is carried out during a recession, aims to “energize” the economy, stimulate the growth of business activity and is used as a means of combating unemployment. Stimulating monetary policy consists in the central bank taking measures to increase the supply of money, which are:

• decrease in reserve requirements;

• reduction in the discount rate;

• purchase by the central bank of government securities.

An increase in money supply leads to an increase in aggregate demand (shift of the aggregate demand curve to the right from AD1 to AD2). This ensures the growth of output from Y1 to the potential output of Y * and, therefore, serves as a means of overcoming the recession and using resources at the level of their full employment.

Fiscal policy

Stimulating fiscal policy is applied during a recession, aims to reduce the recession gap of output and reduce unemployment and is aimed at increasing aggregate demand (total spending). Its instruments are: a) an increase in public procurement; b) tax reduction; c) an increase in transfers.