Fiscal & Monetary Policy - Macro Topic 5.1 - Hey, how you doing, Econ students? This is Mr. Clifford. Welcome to ACDC Econ. Let's review fiscal and monetary policy. [THEME MUSIC] Macroeconomics was created for only two reasons-- to measure the overall economy and to fix it if there's a problem. When it comes to measuring the economy, there's only three possible things that could be happening at any given period of time. The economy can be in a recession. It can be at full employment. Or it can have inflationary gap. Now let's analyze how to fix a problem. Let's start with a recession. If there is a recession, we have only three different options we can use. We can do no policy at all, which is just to wait it out. We can use fiscal policy. Or we can use monetary policy. What you need to know is how do these things affect the overall economy, and what happens on the graph? For example, if we take no policy action at all in a recession, what's going to happen to aggregate supply? Well, since we have high unemployment, eventually wages are going to go down and resource prices will go down, which means costs will go down and aggregate supply will shift to the right. This will put us back at full employment. So remember, the economy is self-correcting over time. So if we do nothing, eventually it will go back to full employment, the long-run aggregate supply. Now what about fiscal policy? There are only two tools in the toolbox of fiscal policy. They are government spending and taxation. So if there is a recession, what do we do to government spending, or what can we do to taxes in order to stimulate the economy and get us out of the recession? Well, we can increase government spending or we can cut taxes. But wait, taxes aren't a shifter of aggregate demand. Well, lowering taxes would increase consumer spending, which would shift aggregate demand to the right. The third option we could use is monetary policy. This is controlling the money supply to affect interest rates and shift aggregate demand. So when we're in a recession, we want to increase the money supply. This will decrease interest rates and increase investment and consumption. That will increase aggregate demand and close a recessionary gap. But what causes an increase in the money supply? I know that we need to increase the money supply. But how do we do it? Well, there's three tools in the toolbox of monetary policy. They are the reserve requirement, the discount rate, and open market operations. So what could the Fed do to each one of these things to get us out of a recession? Well, they can lower the reserve requirement, which means banks can create more money. They can lower the discount rate, which means they can loan out more money to banks. Or they can buy bonds. When the Fed buys bonds, it puts money in the system-- increase in the money supply. So for the bottom two, aggregate demand is increasing. We're speeding up the economy using some sort of government intervention. And the top one, we're just waiting it out and letting aggregate supply increase, putting us back at full employment. Now if you understand all that, it's the same thing over again, except for an inflationary gap. So when we have inflation, we have only three different options. We can do no policy. We can use fiscal policy. Or we can use monetary policy. It's your job to know how each one of these situations will affect the graph and the process by which the economy changes. So pause this video and make sure that you know exactly what's going to happen in each one of these three scenarios. If we wait it out, eventually, when we have inflation, wages will go up and resource prices will go up. So costs go up to firms. Aggregate supply will shift to the left and put us back in full employment. For fiscal policy, we can either decrease government spending or we can increase taxes. Increasing taxes would decrease disposable income and decrease consumer spending, and therefore, decrease aggregate demand. Again, remember, fiscal policy affects aggregate demand, whereas waiting it out and doing no policy action will affect aggregate supply. And for monetary policy, the central bank can either increase the reserve requirement, increase the discount rate, or it can sell bonds. Each of these scenarios would decrease the money supply, which would increase interest rates. That would decrease investment, decrease aggregate demand, slowing down the economy. All right, that's it. Make sure to check out my other videos and my review app. Until next time.