Economic Policy and the Aggregate Demand-Aggregate Supply Model - Section 4, Module 20

stabilization policy - the use of govt policy to reduce the severity of recessions and rein in strong expansions

• bc self correction will take DECADES

limitations - some policy measures to increase AD have long term costs (lower long run growth) AND policymakers are not always well enough informed

to eliminate output gaps, usually monetary policy is used instead of fiscal policy

fixing supply shocks is harder than fixing demand shocks

• also bc two bad things are happening w supply shocks, and if policy is used to shift AD, it fixes one problem but makes the other worse

stabilization policy has led to less fluctuations

taxes can change economy very much

money flows in through taxes and borrowing

• flows out through spending and through transfers:

  • Social security, medicare, Medicaid

  • social insurance - describes govt programs that are intended to protect families against economic hardship

changes in taxes/transfer payments can shift consumer spending → shifting AD curve

• or increase/decrease in govt spending

expansionary fiscal policy - increases aggregate demand through an increase in govt purchases, cut in taxes, increase in govt transfers

contractionary fiscal policy - decreases aggregate demand through a decrease in govt purchases, raise in taxes, decrease in govt transfers

there is often a lag in the use of stabilization policy - shouldn’t be overused bc the lag will end up destabilizing the economy