I þ. For each situation, give an example of a fiscal policy and a monetary policy solution. (p. 15)

a. Rapid investment during a boom period threatens to overheat the economy

b. Layoffs lead to an economic slowdown.

a. Rapid investment during a boom period threatens to overheat the economy.

Fiscal policy solution:

Monetary policy solution:

A:

During a period of rapid investment, there is a corresponding spike in employment and spending power. As spending power increases, inflation also spikes. If left unchecked, this can erode spending power thus reducing the incentive to hold money, trigger panic buying and discourage investment.

Fiscal Policy Solution: Government can decide to reduce it's spending whilst carefully increasing taxes by withdrawing tax rebates and subsidies. The government usually is the biggest spender in most economies if it curtails its spending a lot of funds will be mopped up. Taxes also reduces spending power.

Monetary Policy Solution: increasing discount rates, and reserve requirements will help the Central Bank reduce money supply in the economy. Another method the Central Bank uses to mop up excess money supply is to put on sale government bonds.

B:

Due to whatever reason, when there are massive layoffs, this is usually because the corporate entities, are entering the self-preserving mode, or are actually shutting down due to stringent economic conditions, low money supply, etc. As people get laid off, an important component of demand (Consumer spending) take a nosedive. People save more than they spend as they enter self-preservation mode. This, in turn, creates a cycle of depression. Sales of products drop. Production slows down tending towards a halt. As production slows down, so does profit, and ability to continually pay staff salaries. The result? more layoffs.

Fiscal Policy Solution:

The government can embrace expansionary Fiscal Polieis such as

The above add-up to increase aggregate spending.

Monetary Policy Solution:

Reduction of Discount Rates and Reserve requirements all serve to encourage lending. As lending increases, investments increases, and employment takes on an upward spiral. When people regain their jobs, they become more confident in the economy and this triggers spending.

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