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    Fiscal and Monetary Expansionary Policy

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    Identify two strategies based on fiscal and monetary policy that would encourage people to spend money in order to create economic growth. How could these strategies affect unemployment, inflation, and interest rates?

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    Solution Preview

    You need to refer to income identity: Y = C + I + G + (X - M)
    Y = aggregate demand (eg. GDP)
    C = private consumption
    I = Investment
    G = Government spending
    (X-M) = net export

    For growth strategy, ie to increase Y, the policy should be targeting any one or more of the right-hand variables.

    For fiscal policy, these two strategies can be used to create economic growth:
    1. To encourage consumption (C) directly. This is done by reducing tax rate or tax rebate. People will have more disposable income to spend. As a result public consumption will increase. Recall, this is an injection to the economy. Aggregate income will increase by a factor of greater than ...

    Solution Summary

    Fiscal or monetary expansionary policy can be used to increase aggregate demand or to reduce unemployment. For fiscal policy, tax incentive or government spending can be used while for monetary policy the Fed will increase money supply through open market purchase. However, the side effect of GDP growth is on the pressure for higher price level.