Effectiveness of fiscal policy essay

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Effectiveness of fiscal policy essay

Monetary Policy The government influences investment, employment, output and income through monetary policy. This is done by increasing or decreasing the money supply by the monetary authority. When the money supply is increased, it is an expansionary monetary policy. This is shown by shifting the LM curve to the right.

When the money supply is decreased, it is a contractionary monetary policy. This is shown by shifting the LM curve to the left. Figure 1 illustrates an expansionary monetary policy with given LM and IS curves.

Thus the national income rises from OY to OY1. But the relative effectiveness of monetary policy depends on the shape of the LM curve and the IS curve. Monetary policy is more effective if the LM curve is steeper. A steeper LM curve means that the demand for money is less interest elastic.

The less interest elastic is the demand for money, the larger is the fall in interest rate when the money supply is increased. The more interest elastic is the demand for money, the smaller is the fall in interest rate when the money supply is increased.

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A small fall in the interest rate leads to a smaller increase in investment and income. This shows that monetary policy is less effective in the case of the flatter LM curve and more effective in the case of the steeper curve. If the LM curve is horizontal, monetary policy is completely ineffective because the demand for money is perfectly interest elastic.

On the other hand, if the LM curve is vertical, monetary policy is highly effective because the demand for money is perfectly interest inelastic. Figure 4 shows that when the vertical LM curve shifts to the right to LM with the Increase in the money supply, the interest rate falls from OR to OR1which has no effect on the demand for money and the entire increase in the money supply has the effect of raising the income level from OY to OY1.

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NOW take the slope of the IS curve. If we compare this equilibrium position 2 with the E1position where the curve ISs is steeper, the interest rate OR1 and the income level OY1 are lower than the interest rate and income level of the flatter ISF curve.

With the increase in the money supply, the LM curve shifts to the right to LM1 in Figure 6, the interest rate falls from OR to OR1 but investment being completely interest inelastic, the income remains unchanged at OY.

Figure 7 shows that with the increase in the money supply, the LM curve shifts to LM1. But even with no change in the interest rate OR, there is a large change in income from OY to OY1 This makes monetary policy highly effective. Fiscal Policy The government also influences investment, employment, output and income in the economy through fiscal policy.

This shifts the IS curve to the right. This shifts the IS curve to the left. Figure 8 illustrates an expansionary fiscal policy with given IS and LM curves.The mission of Imperial Valley College is to foster excellence in education that challenges students of every background to develop their intellect, character, and abilities; to assist students in achieving their educational and career goals; and to be responsive to the greater community.

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Effectiveness of fiscal policy essay

Definition of fiscal policy. Fiscal policy involves the government changing the levels of taxation and government spending in order to influence Aggregate Demand (AD) and the level of economic activity. Stimulate economic growth in a period of a recession.

Keep inflation low (UK government has a. Published: Mon, 5 Dec Introduction. Italy is the eighth largest economy in the world with an estimated GDP of USD trillion.

The country has low levels of natural resources with close to 80% of its industrial raw materials being imported. Guide To The HSC Economics Fiscal Policy Essay In this guide I will be focusing on what needs to be included for an essay on fiscal policy, or more specifically the federal budget.

The effectiveness of fiscal policy between the Neo-Keynesian and the Essay