Unit IV: Countercylical Policies: Keynesian Fiscal Policy versus Monetary Policy

In the early 21^st Century, here in the USA:

An efficient, “full employment” economy will probably have:

1.    An annual unemployment rate of 4-5%

2.    An annual inflation rate 2-3%

If the economy goes into recession:

3.    The Real GDP will decrease for at least 6 months.

4.    The unemployment will go to 6% or more.

5.    The inflation rate will probably go to 2% or less.

If the Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:

6.    The policy will try to improve C or G (parts of AD)

7.    Congress decrease federal taxes.

8.    Congress will increase job and spending programs.

9.    The federal budget will probably create a deficit,

10.                       Due to the changes in Money Demand, interest will increase. (Crowding out might occur, but Keynesian don’t care)

If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then:

11.                       The policy will target improvement in the Ig (part of AD)

12.                       The Fed will target a lower federal fund rate.

13.                       The Fed can lower the discount rate.

14.                       The Fed can buy bonds (Open Market Operations)

15.                       The Fed can (theoretically) lower the reserve requirement

16.                       These Fed policies will lower the interest rates through changes in the Money Supply.

17.                       These options should increase Ig.

If the economy suffers from too much demand-pull inflation or cost-push inflation, then

18.                       The unemployment rate will go to 4% or less.

19.                       The inflation rate will probably go to 4% or more.

If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the inflation, then:

20.                       The policy will try to decrease C or G (parts of AD)

21.                       Congress will increase federal taxes.

22.                       Congress will decrease job and spending programs.

23.                       The federal budget will probably create a surplus.

24.                       Due to changes in Money Demand, interest rates will decrease.

If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:

25.                       The policy will target decreases in Ig (parts of AD).

26.                       The Fed will target a higher federal funds rate.

27.                       The Fed can increase the discount rate.

28.                       The Fed can sell bonds (Open Market Operations).

29.                       The Fed can (theoretically) raise the reserve requirement, but probably won’t because it is too complex for the banks.

30.                       These Fed policies will raise the interest rates through changes in the Money Supply.

31.                       These options should lower Ig.