Demand and Fiscal Policy in Recessionary Times

  • Aggregate Demand and Fiscal Policy in Recessionary Times
    [Suggested word count for Q1: 400 to 500 words]
    2020 was a difficult year, and the economy was technically in a recession.
    However, the economy has been recovering from this recession due to the
    timely and effective fiscal stimulus measures adopted by the government.
    A. Use the AD (Aggregate Demand) model to show the impact of the
    decline in consumption and investment on the economy in 2020. Show
    how the fiscal stimulus measures that the government adopted, helped
    the economy to stabilise in 2021. On the same diagram, illustrate and
    explain the process of the multiplier.
    B. Now assume hypothetically, if the government would have cut the
    government spending to reduce the levels of debt and to improve their
    budget balance in 2021. Comment on what would be the possible
    implications of such an early withdrawal of support in the economy. (No
    diagram required for this question).
    Q2 – Unemployment and the WS/PS model in a Post-COVID-19 world
    [Suggested word count for Q2: 300 to 400 words]
    Pandemic containment policies have cut global production which has led to
    rising unemployment in 2020. However, some predict that the coronavirus
    pandemic might stimulate innovation and help workers become more
    productive, e.g. see:
    How Innovation Is Driving Productivity During And Beyond The COVID-19 Pandemic
    Have we just stumbled on the biggest productivity increase of the century?
    In this context, use the WS/PS model to illustrate and explain in some detail
    what happens to an economy’s equilibrium unemployment in a post-COVID-19
    Q3 – Inflation and the Phillips Curve
    [Suggested word count for Q3: 300 to 400 words]
    Assume an economy at labour market equilibrium with stable prices (inflation is
    zero) prior to COVID-19. Due to COVID-19, investment declines, and the
    economy moves into recession with high unemployment. Use the WS/PS/AD
    model to show why and how this would result in a negative bargaining gap.
    Q4 – Monetary Policy Response to the Recent Negative Shock
    [Suggested word count for Q4: 300 to 400 words]
    Expansionary monetary policy has been widely used as a tool recently by the
    central Banks around the world in response to the global pandemic led by
    COVID-19. However, there is an argument that the central banks will probably
    need to aim for a higher level of inflation, as advanced capitalist economies
    attempt to recover from the negative shock, according to these articles:
    Page 1 of 2
    Explain how the transmission mechanism of monetary policy works in a
    recessionary environment to stimulate aggregate demand (AD)? How effective
    were the reductions in nominal interest rates for Australian economy in the
    current global pandemic that started in 2020?

Sample Solution