Fiscal Policy

Discretionary fiscal policy is the deliberate change in government expenditure or tax rates to affect changes to real GDP and unemployment. It was deemed ineffective in the aggregate market model but not in the AE model. The disagreement arises from how the models treat the PL. In the aggregate market model shown in Figure 5.1a, SRAS slopes up. When expansionary fiscal policy is adopted, the PL rises as AD shifts up along SRAS. The higher PL dampens fiscal policy’s expansionary effect on real GDP. In the AE model, the PL is held constant when analyzing the effects of expansionary fiscal policy. This assumption is carried over to the aggregate market model shown in Figure 5.1b by assuming that SRAS is perfectly elastic. ...

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