Answer to Question #199406 in Macroeconomics for Muhammad Ehtesham

Question

 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)

 

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.   (2.5 Marks)

Answer 1

a. The State Bank has chosen a soft monetary policy as a stabilization strategy in response to the unfavorable situation in the world economy caused by the coronavirus and the economy being in a period of fall in the economic cycle. The influence of a stimulating monetary policy on the economy may be shown graphically as follows.

b. The Central Bank will stimulate the economy through the banking sector, while the government will do so through the budget.

The economy is contracting, and the real volume of national production Y1 is smaller than the potential Cu. There is a gap in GNP (Y) in this circumstance, which may be closed by raising total spending from point AE2 to the total expenditure curve AE1, which corresponds to the natural level of output. This can be attributed to an increase in public procurement. The government is immediately confronted with the dilemma of how much public expenditure should be increased in order to totally eradicate the present GNP deficit. This dilemma arises because of the multiplicative effect, which states that increases in total expenditures generate equivalent changes in GNP to a higher extent.