Answer to Question #158199 in Macroeconomics for Laiq Khan

Question

COVID-19 all around the world has restricted the economic activity. To stop the spread of the virus Pakistan like many other countries adopted the policy of smart lockdown. Shutting down of the industry has created adverse supply shock in the economy. While, the slowdown in business and economic activities the country is in the recessionary phase of the business cycle as the GDP growth for the FY 2020-21 is expected to be -0.2 accompanied by high unemployment and poverty rate.

a. Reflecting on the above situation justify whether the State Bank of Pakistan should opt for easy or tight monetary policy as a stabilization policy. Also illustrate it graphically.

(2.5 Marks, Maximum 200 words)

b. Reflecting on the above situation justify whether the Government of Pakistan should opt for expansionary or contractionary fiscal policy as a stabilization policy. Also illustrate it graphically.

Answer 1

a. Due to the negative situation in the global economy due to the coronavirus and the economy being in a phase of decline in the business cycle, the State Bank has adopted a soft monetary policy as a stabilization policy.

graphically, the impact of a stimulating monetary policy on the economy can be depicted as follows

b. The Central Bank will stimulate the economy through the banking sector, and the state through the budget

The economy is in a state of decline, and the real volume of national production Y1 is less than the potential possible Cu. In this situation, there is a gap in GNP (Y), which can be eliminated by increasing the total expenditure from the position AE2 to the total expenditure curve AE1, which corresponds to the natural level of production. And this can be caused by an increase in public procurement. Immediately, the government is faced with the question: how much should we increase public spending to completely eliminate the existing gap in GNP. This question arises because of the multiplicative effect, the essence of which is that an increase or decrease in total expenditures causes similar changes in GNP to a greater extent.