Country X’s banking system has limited reserves and its economy is in a recession. Which of the following combinations of fiscal and monetary policy actions would necessarily move the economy toward full employment in the short run?ResponsesA decrease in government spending and an increase in the discount rateA decrease in government spending and an increase in the discount rateA decrease in income taxes and targeting a higher policy rateA decrease in income taxes and targeting a higher policy rateA decrease in income taxes and a sale of government bonds on the open market by the country’s central bankA decrease in income taxes and a sale of government bonds on the open market by the country’s central bankAn increase in government spending and a decrease in the required reserve ratioAn increase in government spending and a decrease in the required reserve ratioAn increase in income taxes and a purchase of government bonds on the open market by the country’s central bank
Question
Country X’s banking system has limited reserves and its economy is in a recession. Which of the following combinations of fiscal and monetary policy actions would necessarily move the economy toward full employment in the short run?ResponsesA decrease in government spending and an increase in the discount rateA decrease in government spending and an increase in the discount rateA decrease in income taxes and targeting a higher policy rateA decrease in income taxes and targeting a higher policy rateA decrease in income taxes and a sale of government bonds on the open market by the country’s central bankA decrease in income taxes and a sale of government bonds on the open market by the country’s central bankAn increase in government spending and a decrease in the required reserve ratioAn increase in government spending and a decrease in the required reserve ratioAn increase in income taxes and a purchase of government bonds on the open market by the country’s central bank
Solution
The combination of fiscal and monetary policy actions that would necessarily move the economy toward full employment in the short run, given the conditions of Country X, would be an increase in government spending and a decrease in the required reserve ratio.
Here's why:
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An increase in government spending: This is a fiscal policy action. When the government increases its spending, it injects more money into the economy, which can stimulate economic activity and potentially lead to job creation, moving the economy towards full employment.
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A decrease in the required reserve ratio: This is a monetary policy action. The required reserve ratio is the amount of funds that a bank must hold in reserve against specified deposit liabilities. By decreasing this ratio, banks are able to lend more money. This increases the money supply in the economy, lowers interest rates, and encourages businesses and individuals to borrow and spend money, which can stimulate economic activity and potentially lead to job creation.
The other options either involve contractionary policies (which would likely exacerbate a recession) or are neutral/mixed in their potential effects.
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