Chapter 34: The Influence of Monetary and FiscalPolicy on Aggregate Demand

Chapter 34 examines in more detail how the government’s tools of financial policy shift the aggregate demand curve in our model. Mankiw goes over two different effects, the multiplier effect and the crowding-out effect, that help to explain the size of the shift in the AD curve in this chapter. This chapter doesn’t seem too difficult, but that might change. The multiplier effect is the additional shifts in aggregate demand that result when expansionary financial policy increase income and then increase consumer spender, as represented by the multiplier (1/1-MPC). The crowding out effect is an offset in the AD that results when government policy raises the interest rate and reduces investment spending, which causes companies to outsource their investment. The two case studies that were used in this chapter were interesting. The case against active stabilization policy is based on problems that are created by lag. There is the lag that a recession might not be recognized until it’s almost over, and even when it is recognized in time, it takes a while for Congress to take action and then we have to wait again for the actions to have an effect on the recession. Mankiw explains that it is because of this lag that it is almost impossible for the government to effectively pursue action against recessions. There are however, automatic stabilizers in place that take care of the state of the economy, such as the tax system and unemployment compensation, both of which offer a safety net when the economy goes into recession without policymakers having to take any deliberate action.