Monetary and Fiscal Policy - Essay Sample

Introduction

False, SAS curve is upward sloping because of changes in price. That is, in the short run, general price increases will lead to an increase in the amounts of products supplied, while a decrease in the overall level of the price will result in a reduction of the number of the goods provided. The explanation for this is that when products and services cost higher prices, the output becomes more profitable, which causes businesses to increase production and expand provision by using less productive factors of production.

Is your time best spent reading someone else’s essay? Get a 100% original essay FROM A CERTIFIED WRITER!

Order now

LRAS Curve

False, even though the GDP supplied, in the long run, does not change with price changes, the LRAS curve shifts from left to right. The curve can shift left or right depending on changes in the capital stock, the number of workers, and technology. An increase in workers, positive changes in technology, and increased accumulation of machinery will cause a right shift (Luo, 2012). On the other hand, a contraction in any of these variables would cause the slider to move to the left.

AD Curve

This is a false statement. Whereas a decrease in the money supply causes a shift to the left, an increase in price level does not. Aggregate demand is a sum of government expenditure, net exports, consumer spending, and investment. A primary assumption in the AD curve is that the supply of money is fixed. A fall in the amount of money is reflected by a reduction of the nominal output (GDP). The decrease results in a reduction of consumer expenditure on goods and services, which causes a shift of the AD curve to the left. However, a price increase does not create a change in the AD curve. Price is responsible for adjustments along the curve and the downward slope of the curve. There is a leftward shift in the AD curve when components of government spending, consumer spending, net exports, and investment spending fall.

Keynesian Side of SA

Real, during the recession, the price remains unchanged, but output reduces. These changes are visible on the Keynesian portion of the SAS curve. In this region of the SAS curve, an increase of the production does not cause inflation, and the economy is either in recession or depression. This region is characterized by the availability of unemployed workers and large amounts of unused equipment and machinery. However, utilizing these resources would not affect inflation. Use of expansionary monetary policies to increase aggregate demand only increases output but does not cause a change in price. Therefore, appropriate procedures, in this case, would be ones that cause changes in price.

Stagflation

False, stagflation refers to a combination of high unemployment, stagnant economic growth, and high inflation. This situation occurs in an already weak economy, and the level of consumer demand continues to be low enough to prevent price increases. Stagflation occurs as a result of a combination of supply constraints and expansionary monetary policies. An example of this is when the government prints currency or when fiscal policies by the central bank result in credit creation. These policies create inflation and increase the money supply. This happens as other policies slow down growth. This slow pace of growth is attributable to tax increases or increases in interest rates, both of which discourage companies from producing more goods and services. As such, the primary cause of stagflation is a conflict in contractionary and expansionary policies and not an outward shift of the AD curve on the SAS curve.

Money Demand

Interest rates must indeed rise if demand for money exceeds the actual supply. A rise in money demand above the supply could be a result of varying preferences, expectations, and transaction costs that make people desire to hold more money. As such, there is a right shift in the money demand curve. The result of this is that interest rates rise, reducing the rate of investment. The demand for bonds also decreases, and there is also a leftward shift in the demand curve for bonds. This is because institutions resort to selling bonds to acquire more money.

Monetary Policy

False, policymakers have more than one option when it comes to macroeconomic policies. Monetary policy alone is not enough to control the economy (Hommes, Massaro & Salle, 2019). One of these options is fiscal policy, which the US government uses hand in hand with monetary policy to influence the economy. Economic policy is concerned with government spending and taxation and is set through legislation. This tool is critical as it has a significant impact on consumers and directly influences the levels of income and employment rates (Segal, 2019). Fiscal policies can either be expansionary or contractionary depending on the state of the economy at any given moment. Monetary and fiscal policies are both vital macroeconomic tools that influence a nation's economy significantly.

Reserve Requirement Ratio

The reserve ratio determines the amounts of cash held by banks. A reduction in the reserve requirement ratio means that commercial banks are required to reduce the amount of money in hand (Tarver, 2019). This allows them to approve more loans and increase the number and amount of loans available to businesses and customers. In return, consumers and businesses borrow more, which raises the country's supply of money and boosts economic growth. However, with time, the increase in spending activity can lead to the rise in inflation. As such, the statement in question is false.

Money Demand Curve

This is a true statement. The demand curve for money shows the specific amount of money demanded at the prevailing interest rates. The variation in the amount of money requested is a representation of the changes in the spending habits of households and businesses. At higher interest rates, homes and businesses prefer to spend their money in investments and keep less of it in cash. At lower interest rates, there is a higher tendency to hold more cash in cash compared to spending it on investment or bonds. Therefore, businesses and households depend on this interaction between financial institutions to make spending decisions.

Money Supply Curve

This is a false statement. Price and income affect movements up and down the supply curve. On the other hand, a nominal supply increase by the Fed lowers the interest rate while the vice versa holds, such that a fall in the supply of money corresponds with a high-interest rate.

References

Hommes, C., Massaro, D., & Salle, I. (2019). Monetary and Fiscal Policy Design at the Zero Lower Bound: Evidence from the Lab. Economic Inquiry, 57(2), 1120-1140.

Luo, Y. (2012). Aggregate Demand and Aggregate Supply Analysis. Retrieved from http://www.sef.hku.hk/~yluo/teaching/Econ1220/chapter13a.pdf

Segal, T. (2019). Monetary Policy vs. Fiscal Policy: What's the Difference? Retrieved from https://www.investopedia.com/ask/answers/100314/whats-difference-between-monetary-policy-and-fiscal-policy.asp

Tarver, E. (2019). What Happens if the Federal Reserve Lowers the Reserve Ratio? Retrieved from https://www.investopedia.com/ask/answers/071415/what-happens-if-federal-reserve-lowers-reserve-ratio.asp