3 min read•june 18, 2024
Haseung Jun
Jeanne Stansak
Haseung Jun
Jeanne Stansak
Although the economy may seem stable to the common man, when we take a closer look at it there are several ways that we can improve the condition of the economy in the short and long term. It can be corrected through , which is carried out by and the , through , which is carried out by the , or it can self correct itself. A combination of the two can bring out dramatic effects.
Graphing and being able to identify fiscal and monetary policies in action is super important for the AP exam
If we use fiscal policy to correct our economy, it is done through or . If we are looking to speed up our economy because we are in a recessionary gap (negative gap output), we need to increase spending, decrease taxes, or a combination of these two things. When we increase spending or decrease taxes, then that will lead to an increase in either , , or government spending. This will increase the .
If we are looking to slow down our economy because we are in an inflationary gap (positive output gap), then we need to decrease spending, increase taxes, or a combination of these two things. When we decrease spending or increase taxes, then that will lead to a decrease in either consumer spending, investment spending, or government spending. This will decrease aggregate demand (AD).
If we use monetary policy, we can use one of the tools of the Federal Reserve. The most popular tools of the Federal Reserve are the , , and . If we are looking to speed up an economy that is in a recessionary gap, we can decrease the reserve ratio, decrease the discount rate, or buy bonds. This will cause the to increase, which will lower . With lower interest rates, consumers and firms will be more willing to spend money, and we will see an increase in both consumer and investment spending which will increase aggregate demand (AD).
If we are looking to slow down an economy that is in an inflationary gap, we can increase the reserve ratio, increase the discount rate, or sell bonds. This will cause the money supply to decrease, which will raise interest rates. With higher interest rates, consumers and firms will be less willing to spend money, so we will see a decrease in both consumer and investment spending which will decrease aggregate demand (AD).
Finally, if we let the economy self correct itself, we are letting wages naturally increase or decrease in the long run, which will cause the SRAS (short-run aggregate supply curve) curve to either increase or decrease.
Recessionary Gap to Long-Run Equilibrium
Recessionary Gap Correction
Inflationary Gap Correction