Fiscal and Monetary Policy: A Comprehensive Guide

Fiscal Policy

Stimulus

• Purchasing more goods and services (G + N + S)
• Lowering taxes (individual income tax cut, corporate tax cut)
• Increasing income transfers

Restraint

• Decreased government spending (AD = FR = induced decrease)
• Increased taxes
• Reduced income transfers

Classical Economics

1. Supply creates its own demand
2. Excess income should be matched by an equal amount of investment by businesses
3. Interest rates, wages, and prices should be flexible
4. The market is always clear because prices would adjust through the interactions of supply and demand

Keynesian Economics

1. At macroeconomic equilibrium, the economy would experience neither full employment nor price stability
2. Even if the market's macroeconomic equilibrium were perfectly positioned, it would not last
3. Macroeconomic equilibrium
4. Recession (GDP gap)
5. Inflationary (GDP gap)

GDP Measurement Problems

1. Non-market activities
2. Unreported income
3. Double counting
4. Cost of environmental damage
5. Transfer payments
6. Price changes
7. Intangibles
8. Index of well-being

Inflation Effects

Income

• Fixed incomes lose value
• Variable incomes may increase

Wealth

• Real value of savings decreases
• Real value of debt decreases

Causes of Inflation

Demand-Pull

• Increased income
• Additional demand
• Increase in price level
• DP

Cost-Push

• Increased cost for inputs and raw materials
• Increase in price level
• CP

CPI

Price index current year / Price index base year = Basket index current year / Basket index base year

Credit Creation Principles

1. Transactions account balances are a large portion of the money supply
2. Banks can create transactions account balances by making loans

Limits to Credit Creation

1. Deposits - If people prefer to hold onto cash, the deposit creation process will be severely hindered
2. Willingness to lend - Once banks are holding sufficient reserves, they must be willing to make new loans. If banks are reluctant to take risks in lending, they will not fully lend out their excess reserves
3. Willingness to borrow - The third constraint on deposit creation is the willingness of consumers, businesses, and governments to borrow the money that banks make available. If borrowers are reluctant to take on more debt, fewer loans will be made
4. Regulation - The fourth major constraint on deposit creation is the Federal Reserve System. The Fed may limit deposit creation by changing reserve requirements

Unemployment Effects

1. Loss of income
2. Lowered confidence
3. Social stress
4. Health problems

Types of Unemployment

1. Seasonal
2. Frictional
3. Cyclical
4. Structural