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GDP: Fiscal and Monetary Policy

1. Suppose that the real GDP is below potential GDP. Answer the two questions below.
a. What fiscal policy tools could be used to stimulate the economy?
b. What monetary policy tools can the Federal Reserve use to stimulate the economy and increase economic growth. Please identify at least two specific tools.

2. What should the Fed do if it wanted to reduce inflation in terms of the money supply?

3.Both monetary policy and fiscal policy encounter the problems of lags. Discuss the kinds of lags they encounter and the degree of difficulties they present to policymakers.

4. Discuss and explain the concepts of the federal deficit and the national debt. How statistically significant are they for the United States as compared to other countries? Explain how the deficits and the debt arise.

Solution Preview

Monetary and Fiscal Policy
1. Suppose that the real GDP is below potential GDP.
a. What fiscal policy tools could be used to stimulate the economy?
b. What monetary policy tools can the Federal Reserve use to stimulate the economy and increase economic growth? Please identify at least two specific tools.

Fiscal Policy Tools:
To stimulate the economy and boost Gross Domestic Product, government may initiate government purchases. The government usually needs goods and services, supplies and material to keep government agencies running.
Another way of stimulating the GDP is through tax reduction. Businesses and individual purchases will have more disposable income if taxes are low. Entrepreneurs are encouraged to do business when sales tax is at minimum.
Increasing social security benefits also stimulate the economy. Transfer payments are monetary assistance to qualified citizens or families with no other source of livelihood. Transfer payments persuade people to purchase goods and services. This will create a multiplier effect and in turn increases GDP value.

Monetary Policy:
Reducing the interest rates will encourage entrepreneurship. Businesses thrive when interest rates are low. Entrepreneurs find it easy to borrow money from banks. Depositors, on the other hand, find out that low interest rates will result to fewer monetary incentives on deposits. Their tendency is to spend the money in the economy which will give them more monetary incentives. This in turn will boost Gross Domestic Product growth.

2. What should the ...

Solution Summary

This addresses the issue on real GDP vis-a-vis potential GDP, reducing inflation using monetary policies, and concept of deficit and the national debt.

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