Fiscal and Monetary Policy Actions in the Short Run

Fiscal Policy in the Short Run (Review)

Expansionary Fiscal Policy (Recessionary Gap)

Contractionary Fiscal Policy (Inflationary Gap)

Monetary Policy in the Short Run (Review)

Expansionary Monetary Policy (Recessionary Gap)

Contractionary Monetary Policy (Inflationary Gap)

Side-by-Side Comparison

The Key Difference: Interest Rates

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Policy Coordination: Four Scenarios

Scenario 1: Both Expansionary (Recession Response)

Scenario 2: Both Contractionary (Inflation Response)

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Scenario 3: Expansionary Fiscal + Contractionary Monetary

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Scenario 4: Contractionary Fiscal + Expansionary Monetary

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Summary of Policy Combinations

Responding to Different Situations

Why Stagflation Is the Hardest Scenario

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Fiscal vs. Monetary Policy: Advantages and Disadvantages

Fiscal Policy Advantages - Can target specific sectors or populations - Direct impact on AD through government spending - Transfer payments act as automatic stabilizers

Fiscal Policy Disadvantages - **Time lags**: recognition lag (identify the problem), legislative lag (pass the law), implementation lag (spend the money) - **Crowding out**: government borrowing raises interest rates - **Political constraints**: Congress may not agree on action - **Deficit concerns**: increases national debt

Monetary Policy Advantages - **Speed**: Fed can act quickly without legislative approval - **Independent**: not subject to political pressure - **No direct deficit impact**: Fed actions don't add to the national debt - **Double effect through exchange rates**: monetary policy affects both investment AND net exports

Monetary Policy Disadvantages - **Liquidity trap**: ineffective when interest rates are near zero - **Pushing on a string**: can't force banks to lend or firms to borrow - **Indirect**: works through interest rates, not directly on spending - **Uneven effects**: impacts interest-sensitive sectors (housing, autos) more than others

Worked AP FRQ Example

AP Exam Tips

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Common Mistakes