Question

Suppose the U.S. economy is in a recession which is accompanied by deflation. Using the AD/AS...

Suppose the U.S. economy is in a recession which is accompanied by deflation. Using the AD/AS model, cite and discuss 3 possible paths (policy oriented or not—your choice) for the economy to emerge from this recession and return to a long-run equilibrium. Be sure to describe how this recession came to be within the context of the AD/AS model. Do not include any graphs in your answer.   

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Answer #1

Three possible paths that can be used to take the economy out of recession i.e. low demand and deflation low price are given below:

  • Expansionary fiscal policy: An expansionary fiscal policy will increase the demand in the economy. This will increase the price and extra demand in form of government expenditure will take the economy out of recession.
  • Expansionary Monetary policy or easy money policy: The Fed can increase the money supply and reduce the interest rate in the economy. This will give extra money in the hand of people and they will demand more, increasing the price and taking the economy out of recession.
  • Cut taxes in the economy: Cutting taxes in the economy will give extra disposable income in the hand of people. They will demand more and that will increase the price and reduce the recession in the economy.
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