1.

Expansionary fiscal and monetary policies were used as a response to the

Global Financial Crisis of 2008. Which one of the following would show that
expansionary policies were used?
a. Fiscal deficits fell for governments during the crisis.
b. Government spending rose at a slower rate than tax revenue.
c. The central banks bought financial assets, from commercial banks, in
exchange for money to increase the availability of credit. Quantitative easing.
d. Interest rates rose during the crisis.
2. Read the above extracts and answer the following questions.
a. Explain what is meant by the phrase ‘fiscal deficit reduction’ (Extract A)
fiscal deficit reduction is a macroeconomic policy objective of governments in
which they attempt to reduce government spending or increase government
revenue in order to decrease the fiscal deficit. An example of this is fiscal
austerity measures which are typically employed by the UK and US.
According to economists, fiscal austerity measures lead to decreased
aggregate demand in the long run due to a lack of capital expenditure.
b. With reference to Extract A, examine the likely impact of expansionary
fiscal policy in 2008/09, as a response to the Global Financial Crisis, on
real GDP. Expansionary fiscal policy consists of the government attempting
to increase aggregate demand in the economy through the increase in
government spending and decreasing taxation. In 2008/09 there was a
severe economic recession in which aggregate demand greatly contracted.
Expansionary fiscal policy of increasing government capital expenditure
would increase real GDP in the long run. With increased investment in the
economy, such as education, healthcare, and infrastructure, the derived
demand for investment goods would increase short run demand, while in the
long run there would be an increase in the productive potential of the
economy, hence increasing aggregate demand and employment, therefore
real GDP would rise. However, this may be limited if the increased
government spending crowds out private sector spending. Nevertheless,
there would be derived demand for goods produced by the private sector
therefore crowding out may not occur. Furthermore, the expansionary policy
of decreasing taxation would also increase real GDP. With decreased direct
or indirect taxation, there would be an increased demand for goods and
services and the supply of labour would increase, pushing up employment
and consumption, hence increasing aggregate demand and leading to real
GDP growth. However, this is assuming that the taxation is progressive. If the
taxation is regressive, meaning the lower income brackets are taxed highly,
then there may not be an increase in consumption or employment.
c. With reference to Extract B, analyse the likely impact of the rise in US
interest rates on the Indonesian economy. Increased US interest rates
placed pressure on the Indonesian economy due to decreased derived
demand for Indonesian produced goods. With an increase in interest rates in
the United States economy, aggregate demand for goods and services has
decreased, hence the derived demand for Indonesian goods has decreased,
leading to decreased aggregate demand in the Indonesian economy which is
a primarily manufacturing economy. Furthermore, an increase in interest rates
 may lead to increased saving and investment in the American economy which
could lead to capital flight from Indonesia.
d. With reference to the information available, discuss the problems facing policy
makers.
External shocks are a significant problem facing policy makers. For example
the 2008 Global Financial Crisis led to a global decrease in aggregate
demand. This had an especially negative impact on the global economy due
to the peak of globalisation which is the interconnectedness of national
markets into a single international market, making domestic economies
especially vulnerable to supply and demand shocks. The global financial
crisis was provoked by excessive risk taking by financial institutions and
predatory subprime mortgage lending to low income households which
generated an extreme contraction of aggregate demand due to the increased
cost of housing and increased unemployment. For example, the extreme
contraction of aggregate demand in the American economy led to decreased
derived aggregate demand in the European economy due to overdependence
of trade between the two regions.
Another factor is imperfect information which may lead to the misuse of
policies or incorrect policy objectives. An example of this is tax evasion which
may severely impact the governments
Risk