Unit 5: Long-run Consequences of Stabilization Policies

Fiscal Policies

Expansionary Fiscal Policy
- Increases Aggregate Demand (AD) curve in the short run.
- Fixes recessionary gap and creates a budget deficit.
Contractionary Fiscal Policy
- Decreases AD curve in the short run.
- Fixes expansionary gap and creates a budget surplus.
Monetary Policies
- Expansionary Monetary Policy increases AD, helps fix recessionary gaps.
- Contractionary Monetary Policy decreases AD, helps fix expansionary gap.
Combination of Policies
- Influences AD, real output, price level (PL), and interest rates.
- Short-run government deficits can cause inflationary gaps and raise interest rates, delaying economic growth.
- Long-run government deficits contribute to rising government debt.

Short-run Phillips Curve (SRPC)
- Shows trade-off between unemployment rate and inflation rate.
- Negative supply shock shifts SRPC up; positive supply shock shifts SRPC down.
- Demand shocks move the economy along the SRPC.
Long-run Phillips Curve (LRPC)
- Represents the natural rate of employment.
- Intersection of SRPC & LRPC indicates long-run equilibrium.
- Economy is in an inflationary gap if left to the equilibrium, recessionary gap if right.

Rapid expansionary monetary policy can lead to inflation when the economy is at full employment.
Quantity Theory of Money
- Increase in the money supply leads to inflation in the long run.

Government borrowing for a budget deficit increases money demand and interest rates, reducing private investment.
Can result in lower physical capital accumulation and less economic growth in the long run.

Growth Rate of GDP/capita
- Rule of 70: Time to double GDP/capita = 70 / (Annual growth rate).
Sources of Growth
- Labor productivity, influenced by technology, physical and human capital.
- More/better capital and technology lead to increased productivity.
- Policies affecting productivity and employment influence economic growth.