Fiscal and Monetary Policy

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TOMAS L. OLFATO
ANSWERS TO GROUP 4 EXAM
ECON 204
(NOTE: ANSWERS ARE HIGHLIGHTED IN YELLOW)

PART I. (5 points each)

A. An increase in government spending will shift the IS curve to left increasing output with higher interest rate.

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Expansionary monetary policy or Contractionary monetary policy.

a) To maintain the same level of output, what monetary policy should BSP implement?

ANSWER: EXPANSIONARY MONETARY POLICY (Increasing money supply lowers interest rate)

b) To maintain the same level of interest rate, what monetary policy should BSP implement?

ANSWER: CONTRACTIONARY MONETARY POLICY (Reducing money supply results to an increase in interest rate)

B. An inflationary gap occurs when aggregate demand exceeds aggregate supply at full employment level of output. When there is increased spending and availability of money are high, prices start to rise resulting to an inflationary gap. What fiscal policy (Expansionary or Restrictive) should the government implement to dampen growth and lower inflationary pressures(5 points).

ANSWER: RESTRICTIVE FISCAL POLICY (Racing taxes or cutting government spending to dampen GDP(Aggregate Demand) growth and lower inflationary pressures)

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C. A Deflationary gap occurs when aggregate supply exceeds aggregate demands at full employment level of output. The opposite of Inflation, deflation has the side effect of increased unemployment which can lead to economic depression. What fiscal policy (Expansionary or Restrictive) can government implement to stop severe deflation(5 points).

ANSWER: EXPANSIONARY FISCAL POLICY ( Increasing government purchases, decrease in taxes and/or increase in transfer payments closes a recessionary gap, stimulate the economy and decreases the unemployment rate)

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PART II. (2 points each)

True or False:

FALSE 1. The Keynesian school of thought...
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