Macroeconomics

‭this‬‭gap,‬‭governments‬‭resort‬‭to‬‭a‬ ‭contractionary‬‭fscal‬‭policy‬ ‭that‬‭aims‬‭at‬‭reducing‬‭AD‬‭(shifting‬‭its‬‭curve‬ ‭to‬‭the‬‭left)‬‭until‬‭the‬‭short-run‬‭equilibrium‬‭goes‬‭back‬‭to‬‭the‬‭full‬‭employment‬‭level.‬‭However,‬‭reducing‬‭AD‬ ‭in an attempt to control inflation reduces real output and causes an increase in unemployment.‬ ‭A‬ ‭contractionary‬ ‭fscal‬ ‭policy‬ ‭relies‬ ‭on‬ ‭reducing‬ ‭government‬ ‭spending‬ ‭and‬ ‭increasing‬ ‭taxes‬ ‭(to‬ ‭reduce consumption and/or investments) which leads to lower price and real GDP levels.‬

‭↓G → AD ↓ → real GDP ↓ → price level ↓‬ ‭and/or‬

‭↑T → C ↓ and/or I ↓ → AD ↓ → real GDP ↓ → price level ↓‬

‭Study Tip‬ ‭Recall‬ ‭from‬ ‭Chapter‬ ‭3‬‭Section‬‭C‬‭that‬‭the‬‭government‬‭can‬‭use‬‭the‬‭expenditure‬‭and‬‭tax‬‭multipliers‬‭to‬ ‭calculate the changes needed in G and T to close output gaps.‬ ‭Lags of Fiscal Policy‬ ‭Similar to monetary policy, fscal policy has some limitations caused by the following lags:‬ ‭●‬ ‭Data‬ ‭Lag:‬ ‭This‬ ‭refers‬ ‭to‬ ‭the‬ ‭duration‬ ‭required‬ ‭to‬ ‭gather‬‭information‬‭concerning‬‭the‬‭economic‬ ‭conditions‬‭and‬‭status‬‭of‬‭a‬‭country.‬ ‭For‬‭example,‬‭the‬‭delay‬‭in‬‭policymakers‬‭recognizing‬‭a‬‭decline‬ ‭in‬ ‭consumer‬ ‭confdence‬ ‭occurs‬ ‭due‬ ‭to‬ ‭the‬ ‭time-consuming‬ ‭process‬ ‭of‬ ‭collecting‬ ‭output‬ ‭and‬ ‭unemployment data.‬ ‭●‬ ‭Recognition‬ ‭Lag:‬ ‭When‬ ‭data‬ ‭is‬ ‭collected,‬ ‭it‬ ‭takes‬ ‭time‬ ‭to‬ ‭analyze‬ ‭it,‬ ‭determine‬ ‭whether‬ ‭a‬ ‭problem exists, and whether it is temporary or not.‬

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