Question

Econ1A Macroeconomics

Please read the following four examples below. Please identify what they are (i.e., discretionary fiscal policy, monetary policy, or automatic stabilizer) and explain why.  

a) A terrible recession occurs as a result of a bubble in the housing market bursting, and government-funded unemployment compensation is paid out to laid-off workers. (5 points)

b) As the economy heats up, the resulting increase in equilibrium GDP results in higher income tax payments, which dampen consumption spending somewhat. (5 points)

c) To stem an overheated economy, the president, using special powers granted by Congress, authorizes emergency impoundment of funds that Congress had previously authorized for spending on some government programs to help reduce government spending (G), and thus help reduce inflation. (5 points)

d) The Federal Reserve decides to increase the money supply in order to help lower interest rates and stave off a more severe recession. (5 points)

Answer 1

(a) When the government has to spend more for unemployment compensation, it is an automatic stabilizer because unemployment compensation increases during recession (since number of unemployed rises) and decreases during expansion (since number of unemployed falls) without government intervention.

(b) When the economy heats up and tax revenue rises, it is an automatic stabilizer because tax revenue decreases during recession (since taxable income falls) and increases during expansion (since taxable income rises) without government intervention.

(c) An emergency fund impoundment is an example of discretionary contractionary fiscal policy aimed to lower aggregate demand and inflation.

(d) An increase in money supply is an example of discretionary expansionary monetary policy aimed to increase aggregate demand by reducing interest rates.