Monetary and Fiscal Policy in the Short Run

Why are policies implemented

• Close output gaps

• If in a recessionary gap, lower unemployment

• if in inflationary gap, lower inflation

• These policies are implemented through fiscal policy (manipulating AD by changing spending and taxes) and monetary policy (manipulating AD by changing interest rates)

• A combination of fiscal and monetary policies can influence AD, real output, price level, and interest rates

• Contractionary monetary policy decreases price level by raising interest rates, which discourages borrowing and reduces consumer spending. This helps to decrease aggregate demand, thus alleviating inflationary pressures in the economy.