Expansionary Monetary Policy

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Expansionary Monetary Policy

Expansionary fiscal policy, such as the Chancellor of the Exchequer deciding to reduce the standard rate of income tax leads to higher aggregate demand and an increase in equilibrium income and output. In this essay I will examine the factors that are important in determining the macroeconomic effects should such a policy be installed by Gordon Brown (Chancellor of the Exchequer), and I will comment on any suggestions I may have for Gordon Brown in the preparation of his next budget with a brief description on the assumptions that my advice is based.

Macroeconomic Goals

Firstly I would like to examine the macroeconomic goals/aims of Gordon Brown and his fiscal policy. Fiscal policy is the governments plan for spending and taxation, it is designed to steer aggregate demand in some desired direction, which we will investigate in greater detail later on today. Macroeconomic policy is a phrase used to describe actions taken by governments to manipulate the economy to influence the level of inflation and unemployment. Along with balance of payments and high stable economic growth, low inflation and high employment are two of the main four macroeconomic goals of the government. In practice, macroeconomic policies could be used to refer either to policies sought to influence aggregate supply or to policies that sought to influence aggregate demand. We will investigate aggregate supply and aggregate demand both in the long run and in the short run and show their effects on macroeconomic policy.

In this graph we can see that as a result of a decrease in income taxes, aggregate demand will shift to the right from AD to AD1. Aggregate supply in the long run is a vertical line that keeps Y at the natural rate of Y*, which inturn produces constant output and increased prices which is an affect of increased inflation.

Here we can see that aggregate supply in the short run is a horizontal line. An increase of the aggregate demand curve form AD to AD1 results in increased output should income taxes be decreased while keeping the price level constant at P*. In this example Gordon Brown is able to achieve at least 3 of his 4 macroeconomic goals. Growth being the obvious as output increases from Y to Y1, increased growth produces jobs hence increased employment, all while the price level stays constant at P...

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...o be fast acting and make him look favorable in the public eye. The economy currently is prospering so my initial advice to Mr. Brown would be to leave a good thing alone and leave the income tax rate as is. However coming up on an election Mr. Brown wants to show me that he’s doing something for me and a tax cut will be looked upon favorably in the public eye. Mr. Brown might consider cutting taxes and in the long run as discussed above the economy will keep the price level constant et increase output, he can deal with fixing the long run consequences of an increased price level and a return to the natural rate of Income after he is elected. To the non-economist a decrease in taxes will seem beneficial due to the increase in aggregate demand: Output will increase, employment will increase as will the wage rate, all while the interest rate stays constant. Assuming that Mr. Brown doesn’t have any personal goals and is solely interested in the well being of the U.K. economy I would suggest to keep the current fiscal policy, for reasons backed up by the Ricardian Equivalence and the fact that the current macroeconomic conditions in the U.K. are favorable and don’t need to be fixed.
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