5.1 Fiscal and Monetary Policies Short Run

Recessionary Gap

FISCAL is best

Inflationary Gap

MONETARY is best

Recessionary Gap: No Policy

1. Wages decrease = Input Costs decrease = SRAS →

Recessionary Gap: Fiscal

1. Gov Spending increase = AD →

2. Taxes decrease = Disposable income increase = Consumer Sp increase = AD →

Recessionary Gap: Monetary

1. Limited Reserves

   • RR decr OR Disc decr OR OMO buy bonds = MS increase = ir decrease = Investment increase = AD→

2. Ample

   • IOR decrease

   • Lowers incentive for banks to keep reserves, so they loan it out

Inflationary Gap: No policy

1. Wages increase = Input costs increase = SRAS ←

Stagflation!

Inflationary Gap: Fiscal

1. Gov sp decrease = AD ←

2. Taxes increase = Disposable income decrease = C decrease = AD ←

Inflationary Gap: Monetary

1. Limited

   • RR increase OR Disc increase OR OMO sell bonds = MS decrease = ir increase = Investment decrease = AD ←

2. Ample

   • IOR increase

   • Increase incentive for banks to keep reserves, so they loan out less