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Module 3 Reflection

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Mariane Sidibe

May 19, 2020

Module 3 Reflection

Chapter 12

In this chapter, we were introduced to the Keynesian perspective where various concepts were explored – aggregate demand, the building blocks of Keynesian analysis, the Phillips curve, and the Keynesian perspective on market forces. Based on the Keynesian view, businesses produce products only when they expect them to sell. It means that the demand present drives the real GDP across the economy. Aggregate demand is comprised of several components: government spending, investment expenditure, consumption expenditure, and spending on net exports. Keynes also argues that aggregate demand is responsible for recessions. First, recessions occur when demand for products is less than the output at full employment. Second, it can occur due to sticky wages and prices, resulting in unemployment. It is attributed to various internal costs that firms incur when changing prices, such as accounting and labeling.

The Philips curve shows that a tradeoff exists between the unemployment rate and the inflation rate; when unemployment is high, inflation is low, and vice versa. However, this tradeoff is short-term: in the long-term, it appears to shift out. Supply shocks cause the shifting out of the Phillips curve and when people expect changes in inflation. Based on this, Keynes suggests that recessions can be resolved through expansionary fiscal policy like reducing the tax to promote investment and consumption, causing aggregate demand to shift to the right. On the other hand, a contractionary fiscal policy like tax increase would fight inflation. This shows that the government has a vital role in managing the economy, which is increasing aggregate demand to allow the economy to reach full employment. However, the government should not assume the role of setting prices and wages at microeconomic markets.

Chapter 14

In this chapter, we learned various concepts regarding monetary policy and bank regulation. First, we learned about the central bank, which is the organization that conducts monetary policy and ensures that the financial system of a country run efficiently. The central bank uses various strategies to conduct monetary policy in the economy: open market operations, increase or reduce reserve requirements, and changing the discount rate. The open market operation, which is mostly used, involves the central bank buying or selling U.S. Treasury bonds to adjust the level of interest rates and the quantity of bank reserves. Quantitative easing is another tool, although non-traditional, used to conduct monetary policy. The central bank buys long-term government and private mortgage-backed securities to expand the supply of credit. It was used primarily during the 2008-09 recession.

The implementation of monetary policy results in several economic outcomes, but the outcomes are different depending on the kind of monetary policy conducted. Contractionary monetary policy, also referred to as tight monetary policy, increases interest rates and minimizes borrowing. It affects aggregate demand by causing a decline in business investment and consumer borrowing for expensive items like cars and houses due to high-interest rate. On the contrary, expansionary monetary policy or a loose monetary policy reduces interest rates, which encourages business investment and consumer borrowing for expensive items. However, monetary policy has various pitfalls – its effects are felt after long and variable lags, it cannot force the banks to lend if they decide to hold excess reserves, and velocity may change in unpredictable ways, causing problems.

Chapter 16

In this chapter, we were introduced to government spending and fiscal policy. One of the key concepts discussed in this chapter is government spending. Almost 70% of government spending occurs in the following four sectors – including Social Security, national defense, interest payments, and healthcare. The government spends money collected from taxes – more spending than tax collected results in the budget deficit, while spending less than taxes leads to a budget surplus. When government spending and taxes are equal, it results in a balanced budget. The budget surpluses and deficits for the past years make up government debt. A large percentage of the federal revenues come from individual taxes and payroll taxes – they account for about 80%. Other federal taxes that provide revenue for the federal government are excise taxes on alcohol, gasoline, and tobacco, corporate income tax, and the estate and gift tax.

Another essential concept covered in this chapter is the use of fiscal policy to counteract recession, unemployment, and inflation. Fiscal policy uses tax policy and government spending to influence the economy. Expansionary fiscal policy deals with recession through tax cuts, which increases government spending, business investment, and consumer spending due to increased disposable income. The contractionary fiscal policy does the opposite to lower inflation. In some instances, it may use other fiscal policies, such as discretionary fiscal policy, which involves government instituting a new law to change tax rates and government spending.  Moreover, during the recession, changes in government spending and tax may occur automatically because of automatic stabilizers like food stamps and unemployment insurance to increase aggregate demand. However, the use of discretionary fiscal policy has some problems, which has made many economists claim that it should only be used during extreme economic times.

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