Answer to Question #226519 in Macroeconomics for hafsa

Question

In figure 12-10 the economy can move to full employment by an expansion in either money or the full-employment deficit. Which policy leads to E₁ and which to E₂? How would you expect the choice to be made? Who would most strongly favor moving to E₁ versus E₂? What policy would correspond to “balanced growth”?

Answer 1

The IS curve shows an inverse relationship between output and interest. It depicts a market for commodities that is in equilibrium. The LM curve, on the other hand, shows a direct link between interest and output. Money and asset markets are in equilibrium, as seen by the LM curve. Expansionary fiscal policy is used to reach equilibrium point E1 as indicated in the diagram -1. In order to get to point E2, an expansionary monetary policy is used. The use of expansionary fiscal policy results in crowding out when interest rates rise, and rising interest rates restrict investment.

Without an increase in investment, the government will have to bear more of the cost by lowering taxes and boosting government spending. However, as interest rates decrease as a result of the Fed's expansionary monetary policy, investment rises. Bond prices fall as a result of expansionary monetary policy, and demand rises. Both policies have advantages and disadvantages. The policy mix is the ideal option because if the country wants to encourage investment, it should adopt expansionary monetary policy because it lowers interest rates and so increases investment. During a recession, lower taxes are the best option, however during a boom era, taxes may rise. Moving to E1 is greatly favored by the government or politicians because it results in more votes due to lower taxes and the crowding effect of government power on share increases.

The optimum approach for achieving full employment is a combination of fiscal and monetary policy. Because they each have their own merits and flaws, policymakers must consider both government and private business interests.