What is the difference between contractionary and expansionary monetary policy? What is the difference between contractionary and expansionary fiscal policy? How does each policy affect the AD in the economy?

The contractionary monetary policy encompasses a policy employed by the central bank that decreases the amount of money in circulation. On the other hand, expansionary monetary policy entails a policy that increases the circulation of money in the economy. One of the monetary policy is the interest rate. When the economy experiences inflation, the central bank will use contractionary monetary policy, high-interest rates. This will increase the cost of borrowing from financial institutions leading to low investment and low aggregate demand. Similarly, when the supply of money in the economy is low, the central bank will employ expansionary fiscal policy, low-interest rate. This will encourage private investors and other individual to borrow money from financial institutions hence increasing the aggregate demand.

Expansionary fiscal policy can be explained as a policy used by the government to increase the economic activity in the country. On the other hand, contractionary fiscal policy entails a policy employed by the government to slow down the economy. One of the Fiscal policy is government spending. When the economy is growing slowly, the government use expansionary fiscal policy, increase spending, and this will increase the aggregate demand. Similarly, during an economic expansion, the government will employ a contractor fiscal policy, decrease spending, and this will decrease the aggregate demand.

What are the benefits and major problems of the fiscal policy and monetary policy?

Fiscal policy is useful in reducing demand-deficiency unemployment. When the government changes taxation and also increase its spending, the national income will increase due to the increase in aggregate demand. The problem with this policy is that it might result in conflicts between objectives. For example, expansionary fiscal policy designed to increase aggregate demand and reduce the level of unemployment may worsen inflation in the economy.

A monetary policy such as the rate of interest offers considerable flexibility. It is because the central bank can change the rate of interest at short notice and also regular interval and still have a significant effect on the short-term economic activity. The problem with monetary policy is time lags. After the central bank has employed monetary policy, it may take up to 18 months for the policy to influence aggregate demand.

If you were macroeconomic policymaker, how do you balance the short-run tradeoff between inflation rate and unemployment rate? Explain.

As a policy maker, I will recommend the Fed to unexpected inflation. Once individuals expect inflation, the Fed can get unemployment below the natural rate when the actual inflation is above the anticipated rate. Since people’s expectations are formed rationally and the expansionary policy is also credible, the Philips curve will shift to the right. In the short-run, inflation will increase but the unemployment rate remains at the natural rate. Therefore, there is no short-run trade-off between inflation and unemployment.

What is the historical relationship between rates of unemployment and inflation in the U.S. economy? What are the most current figures for the unemployment rate and the inflation rate? What does this say about the U.S. economy today?

During the 1960s, the experience of the US implied that there was a tradeoff between the unemployment rate and rate of inflation. It was based on the unexpected increase in price, increase in demand for labor and reduction in unemployment.

The current unemployment rate in the US is 5.0% while the inflation rate is 0.2% (Bureau of Labor Statistics, n.d). The economy of the US is stable because of the low inflation rate and unemployment rate. Therefore, the US experiences a healthy growing economy.

Reference

Bureau of Labor Statistics. (n.d). Retrieved from http://data.bls.gov/timeseries/LNS14000000

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