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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