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Expansionary policy
- Policymakers may choose to implement an expansionary policy —a stabilization policy—to close the gap and increase real GDP. Monetary authorities might increase the amount of money in circulation in the economy by lowering interest rates and boosting government spending.
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Faced with a recessionary or an inflationary gap, policy makers can undertake policies aimed at shifting the aggregate demand or short-run aggregate supply curves in a way that moves the economy to its potential.
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A recessionary gap, or contractionary gap, is a macroeconomic term used when a country's real gross domestic product (GDP) is lower than its GDP at full employment.
Essentially, a recessionary gap refers to the difference between actual and potential production in an economy, with the actual being lower than the potential, which puts downward pressure on prices in the long run. Often, these gaps are evident during an economic downturn and are associated with higher unemployment numbers. Significant reductions ...
When production levels fluctuate, prices change to compensate. This price change is considered an early indicator that an economy is moving into a recession and may lead to less favorable exchange ratesfor foreign currencies. An exchange rate is merely one country's currency in comparison with that of another country. At parity, the two currencies ...
Although it represents a downward economic trend, a recessionary gap can remain stable, suggesting short-term economic equilibrium below the ideal, which can be as damaging to an economy as an unstable period. This instability is because prolonged downward periods of lower GDP production inhibit growth and contribute to sustained higher unemploymen...
A more important outcome of a recessionary gap is increased unemployment. During an economic downturn, the demandfor goods and services lowers as unemployment rises. If prices and wages remain unchanged, this can further elevate unemployment levels. In a cycle which feeds upon itself, higher unemployment levels reduce overall consumer demand, which...
In December 2018, the U.S. labor market as a whole was at full employment with an unemployment rate of 3.9% and there was no recessionary gap.However, not all parts of the country were at full employment, and some individual states were experiencing a recessionary gap. For instance, New York was at full employment, and most large cities were econom...
Sep 5, 2024 · Policymakers can employ several strategies to close a recessionary gap and stimulate economic recovery: Monetary policy: Central banks can lower interest rates to make borrowing cheaper, encouraging consumer spending and business investment.
- Automatic Stabilizers. Certain government expenditure and taxation policies tend to insulate individuals from the impact of shocks to the economy. Transfer payments have this effect.
- Discretionary Fiscal Policy Tools. As we begin to look at deliberate government efforts to stabilize the economy through fiscal policy choices, we note that most of the government’s taxing and spending is for purposes other than economic stabilization.
- Changes in Government Purchases. One policy through which the government could seek to shift the aggregate demand curve is a change in government purchases.
- Changes in Business Taxes. One of the first fiscal policy measures undertaken by the Kennedy administration in the 1960s was an investment tax credit. An investment tax credit allows a firm to reduce its tax liability by a percentage of the investment it undertakes during a particular period.
When the economy has a gap, policy makers can choose to do nothing and let the economy return to potential output and the natural level of employment on its own. A policy to take no action to try to close a gap is a nonintervention policy. Alternatively, policy makers can choose to try to close a gap by using stabilization policy.
The policy solution to a recessionary gap is to shift the aggregate expenditure schedule up from AE 0 to AE 1, using policies like tax cuts or government spending increases. Then the new equilibrium E 1 occurs at potential GDP.
Faced with a recessionary or an inflationary gap, policy makers can undertake policies aimed at shifting the aggregate demand or short-run aggregate supply curves in a way that moves the economy to its potential.
