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QUESTION:
Should the government use monetary and fiscal policy in an effort to stabilize the economy? The following questions address the issue of how monetary and fiscal policies affect the economy, as well as the pros and cons of using these tools to combat economic fluctuations.
The following graph plots hypothetical aggregate demand (AD), short-run aggregate supply (AS), and long-run aggregate supply (LRAS) curves for the U.S. economy in February 2026.
Suppose the government chooses to intervene in order to return the economy to the natural level of output by usingpolicy.
Depending on which curve is affected by the government policy, shift either the AS curve or the AD curve to reflect the change that would successfully restore the natural level of output.
Suppose that in February 2026 the government successfully carries out the type of policy necessary to restore the natural level of output described in the previous question. In July 2026, U.S. imports decrease because the United States has implemented trade restrictions on Mexican goods. Due to theassociated with implementing monetary and fiscal policy, the impact of the government's new policy will likelyonce the effects of the policy are fully realized.
ANSWER:
Should the government use monetary and fiscal policy in an effort to stabilize the economy? The following questions address the issue of how monetary and fiscal policies affect the economy, as well as the pros and cons of using these tools to combat economic fluctuations.
The following graph plots hypothetical aggregate demand (AD), short-run aggregate supply (AS), and long-run aggregate supply (LRAS) curves for the U.S. economy in February 2026.
Suppose the government chooses to intervene in order to return the economy to the natural level of output by usingan expansionarypolicy.
Points:
1 / 1
Depending on which curve is affected by the government policy, shift either the AS curve or the AD curve to reflect the change that would successfully restore the natural level of output.
Points:
1 / 1
Close Explanation
Explanation:
The current level of output occurs where the AD curve intersects the AS curve. Because this level of output is less than the natural level of output (the level of output where the LRAS curve intersects the AD curve), the economy is experiencing a recession. An expansionary policy leads to an increase in aggregate demand. The goal would be to increase aggregate demand until it intersects the short-run aggregate supply curve at the natural level of output, or $26 trillion.
Suppose that in February 2026 the government successfully carries out the type of policy necessary to restore the natural level of output described in the previous question. In July 2026, U.S. imports decrease because the United States has implemented trade restrictions on Mexican goods. Due to thelagsassociated with implementing monetary and fiscal policy, the impact of the government's new policy will likelypush the economy beyond the natural level of outputonce the effects of the policy are fully realized.
Points:
1 / 1
Close Explanation
Explanation:
The intention of the expansionary fiscal or monetary policy was to increase aggregate demand and close the gap between actual real GDP and the natural level of output. However, monetary and fiscal policy can suffer from time lags. For fiscal policy, in order for a change to be enacted, it must go through a time-consuming political process, causing action to be delayed for months and sometimes years. For monetary policy, the resulting change in interest rates does not alter spending plans immediately because firms and businesses plan their financial decisions well in advance; this lag is measured at roughly 6 months.
In this case, after the expansionary fiscal or monetary policy is enacted in February, the economy has begun to improve thanks to the increase in aggregate demand from the decrease in imports from Mexico. Because of this, the expansionary fiscal or monetary policy will likely cause the aggregate demand curve and the short-run aggregate supply curve to intersect beyond the natural level of output once the effects of the policy are fully realized:
This is the primary argument against active monetary and fiscal policy to stabilize the economy. Because of time lags, it is likely that by the time discretionary policies begin to exert an effect, conditions will have changed sufficiently to make the original policy unnecessary and sometimes unwise. Opponents of discretionary policies believe that a stabilizing policy can actually destabilize an economy unintentionally.
policy.