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Chapter Review Chapter 33: The Role of Macroeconomic Policy

  1. The actual fiscal deficit increases in a recession as tax revenues decline. This process provides an important automatic stabilizer. To measure discretionary shifts in fiscal policy, economists look at the full-employment budget deficit.
  2. The aggregate demand–inflation (ADI) curve depends on the monetary policy rule used by the central bank. The slope of the policy rule affects the slope of the ADI curve, while shifts in the policy rule are reflected in shifts in the ADI curve.
  3. If the central bank wants to keep inflation stable, it must adjust its policy rule whenever the equilibrium full-employment real interest rate changes. The policy rule must be shifted up if the full-employment real interest rate increases, leading to a higher nominal interest rate at each inflation rate.
  4. The monetary policy rule shifts if the central bank alters its target for inflation. If it reduces its inflation target, the policy rule shifts up, leading to a higher nominal interest rate at each rate of inflation.
  5. Both fiscal and monetary policies can affect aggregate demand and output in the short run. They have different effects on the interest rate. A fiscal expansion raises the real interest rate; a monetary expansion lowers the real interest rate. Consequently, investment will be higher in the short run if monetary policy is used to stimulate the economy.
  6. The inside lag is shorter for monetary policy than for fiscal policy. The outside lag is shorter for fiscal policy.
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