1 Explain what fiscal policy is and how it works What kind o

1. Explain what fiscal policy is and how it works. What kind of fiscal policy would be most appropriate in response to a stock market collapse? What kind of fiscal policy would be most appropriate in response to rising inflation?

2. Do you agree or disagree with this statement: “It is in the best interest of our economy for Congress and the President to run a balanced budget each year.” Explain.

3. Use US Treasury site (www.treasurydirect.gov) to record the size of the total public debt. Some people think that a large public debt will bankrupt the United States government because the government will not be able to meet its financial obligations. Do you agree or not that large debt a problem? Explain why.

Solution

1. Fiscal policy is how government influence the economy by adjusting it\'s spending or tax collection. Government only can effect the aggregate demand by taking these fiscal policies. Fiscal policies can be of two types - expansionary fiscal policy, which is taken when the economy is in recession and contractionary fiscal policy, which is used when the economy is facing inflation.

A stock market collapse hurt business and consumers confidence and this may result in a recession(because real output decreases). An expansionary fiscal policy i.e. increase government spending and/or, decreasing tax rate helps the Aggregate demand to increase and to stabilize the economy by increasing real GDP.

A contractionary fiscal policy (i.e. increase tax rate and/or, decrease government spending) will help to solve the problem of rising inflation. As this policy decreases AD and shifts it leftward and as a result, price level decreases.