s7 summary on Fiscal and Mo! Pe 1. Recessionary (Deflationary) and Inflationary Gaps A deflationary income gap can be closed by expansionary policies. {An inflationary income gap can be closely by contractionary p 2. Crowding-out Effect An expansionary policy will increase the interest rate and reduces interest-sensitive private spending e.g. investment. The crowding-out effect will reduce the policy effectiveness of fiscal policy. GA (AD ® KEDG TN) DY D> Md MEDM)> rR D1Y The reduction in investment will offset part of the increase in AD and restrain the increase in national income. 3. Fiscal Policy is effective when kis large (or the marginal withdrawals is smaller e.g. st, m); eislarge; dissmall;and bis small Fiscal policy is more effective if the LM curve is flatter. Fiscal policy is more effective, if holding k constant, the IS curve is steeper. 4. Monetary Policy is effective when kis large (or the marginal withdrawals is smaller e.g. st, m); eissmall; dissmall;and bis large Monetary policy is more effective if the IS curve is flatter (i.e. when k or b is larger) Monetary policy is more effective if given the same d, the LM curve is steeper. 5. Special cases for fiscal policy and monetary policy Most Effective Ineffective IS Curve UM Curve IS Curve UM Curve Fiscal Policy b: e=0 b=o e=0; Vertical Horizontal Horizontal —_ Vertical Monetary Policy b= 00; e=0; b=0; e= 0; Horizontal Vertical Vertical Horizontal