[Study Notes] Macroeconomics – Fiscal & Monetary Policies

The economy is controlled by two policies:

  • Fiscal (by Government): Taxes and Expenditures
  • Monetary (by Central Bank): Money supply and Interest rate

THE FOLLOWING NOTES ARE THE BASIC CONCEPTS IN THE MAINSTREAM (CAPITALISTIC, NEO-CLASSICAL) ECONOMICS.

FISCAL POLICIES

Government spending and Taxes are the main weapon to control the level of economic activities (by Keynesian school).

To increase the level of economic activity:

  • Increase Government expenditure
  • Decrease taxes

In the equilibrium:

  • Government Expenditure + Investment Expenditure = Taxes + Savings
  • Any variation of this will cause inflation or unemployment.

TRADE-OFF IN KEYNESIAN MODEL

There is a trade-off between unemployment and inflation.

  • Stagflation: In the late 60s and 70s, the US experienced high inflation and high unemployment due to the increased government expenditure, oil shock, and heavy international competition.
    • Keynesian model can only solve half of the problem (inflation or unemployment, not both)
  • Fixes: Monetarists suggests that the severe short-term recession with the high-interest rates can fix the stagflation

MONETARY POLICIES

Investment behavior depends on interest rates.

  • Higher interest rates discourage investment
  • Low-interest rates encourage investment

The central bank (such as Federal Reserves in the US) can influence investment by changing interest rates.

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