Recession= a period where national output (GDP) falls for 6 months or more GDP= the value of output produced

within the country over a 12-month period National product= National income= National expenditure (Govt income/revenue-from taxes must equal govt expenditure, so they must move towards this equilibrium point by either cutting taxes and raising expenditure (expansionary fiscal policy) or increasing taxes and reducing expenditure (deflationary/contractionary fiscal policy). GDP= C+I+G+X-M = AD (C=consumer spending, I=private investment, G=government expenditure on goods and services, X=expenditure on exports, M=expenditure on imports) AD= C+I+G+X-M (C=consumer spending, I=private investment, G=government expenditure on goods and services, X=expenditure on exports, M=expenditure on imports) I+G+X= Injections (J) S+T+M= Withdrawals (S=saving, T=taxes, M=imports) C+W=Y (consumption + withdrawals = income) Unemployment: excess demand for labour- vacancies; excess supply for labour- unemployment The fiscal policy focuses on Influences the level of economic activity through manipulation of government income and expenditure Influences AD tax regime influences consumption (C) and investment (I) Government spending (G)

Influences AD in the short-term but can be used to affect AS in the long run- depending on the nature of the policy The monetary policy is based on the assumption that A rise in the money supply might signal a rise in the aggregate demand! A rise in Ms will lead to an increase in the price level. Attempts to influence the economic activity (the amount of buying and selling in the economy) through changes in the money supply and the price of money i.e. short-term interest rates Supply-side policies: tend to be long-term policies; intention is to shift the AS curve to the right, increasing the long-term productive capacity of the economy. They argue that lowering taxes increases incentives, reducing welfare dependency increases the urge to find work Policies aim to influence productivity and efficiency of the economy

Key feature open up markets and de-regulate to improve efficiency in the working of market and the allocation of resources 2. Demand-side Policies The level of prices in the economy reflects the level of inflation and is determined by looking at the relationship between aggregate demand and aggregate supply. Simple Keynesian analysis of unemployment and inflation The simple Keynesian theory assumes that there is a maximum level of national output and hence real income that can be obtained at one time. If the equilibrium level of income is at this level, there will be no deficiency of aggregate demand and hence no disequilibrium unemployment. This level is referred to as the full-employment level of national income. The deflationary/recessionary gap = the shortfall of national expenditure below national income (and injections below withdrawals) at the full-employment level of national income (the amount by which national income exceeds aggregate expenditure at the full-employment level of national income) Figure 1: Recessionary Gap

Source: Sloman & Wride, 2009 As illustrated in figure 1, the level of equilibrium is at Ye, where the national income is equal to the national expenditure i.e. Y=E and the injections into the economy are equal to the withdrawals (W=J). While moving towards full-employment, which is pointed out on the diagram by the vertical line at YF, a deflationary gap a b forms between the Y (the 45 line) and E curves, representing the amount by which income exceeds government expenditure. Similarly, another gap, c d, occurs between the W and J curves, showing the amount by which withdrawals are greater than injections. The inflationary gap: The excess of national expenditure over income (and injections over withdrawals) at the full-employment level of national income.

Source: Sloman & Wride, 2009

The relationship between the AD/AS diagram and the 45 line diagram

Source: The multiplier: a shift in injections a shift in withdrawals a shift in the expenditure curve

Demand-side policies are anti-inflationary policies used to control the aggregate demand. There are two types of demand-side policies: fiscal policy and monetary policy. 2.1 Fiscal Policy Fiscal policy involves altering the level of government expenditure and/or rates of tax so as to affect the level of aggregate demand. AD= C+I+G+X-M (C=consumer spending, I=private investment, G=government expenditure on goods and services, X=expenditure on exports, M=expenditure on imports) Expansionary fiscal policies raise government expenditure (an injection into the circular flow of income) or reduce taxes (a withdrawal from the circular flow). => AD increases => a multiplied rise in national income. Policy used to prevent mass unemployment or a recession (to remove any severe deflationary or inflationary gap). Also used to increase the budget deficit or reduce the budget surplus. Budget deficit: govt expenditure > govt revenue (from taxation) To finance a deficit, the government will have to borrow (e.g. through the issue of bonds (gilts) or Treasury bills). => an increase in the money supply to the extent that the borrowing is from the banking sector. The substantial increase in deficits, and hence debt, in 2008 governments borrowed more to finance extra spending and/or tax cuts to control recession. Budget surplus: govt revenue > govt expenditure In 2008/9, the governments around the world increased their expenditure and cut taxes in an attempt to stave off recession. Deflationary fiscal policy cut government expenditure and/or raise taxes. Policy used to prevent excessive inflation Fiscal policy also used to smooth out the fluctuations in the economy associated with the business cycle: When the economy begins to boom reduce government expenditure and raise taxes When a recession looms the government should cut taxes or raise government expenditure in order to boost the economy.

The underlined words (cut/raise govt expenditure and taxes) are called stabilisation policies. 2.1.1 Effectiveness of Fiscal Policy Crowding out Random shocks Time lags Policy may be stabilising or destabilising

2.1.2 Fundamental Criticisms of Keynesian Fiscal Policy New Classical View Monetarist View 2.2 Monetary Policy Monetary policy involves altering the supply of money in the economy or manipulating the rate of interest. The central bank can reduce AD (a contractionary monetary policy), by putting up interest rates and thus making borrowing more expensive, or by acting to reduce the supply of money available through the banking system. If people borrow less, they will spend less. 2.3 Rules versus Discretion 2.4 The IS-LM Analysis of Fiscal and Monetary Policy Keynesian view: effectiveness of fiscal policy and ineffectiveness of monetary policy Monetarist view: effectiveness of monetary policy and ineffectiveness of fiscal policy

4. Putting theory into practice- The recession in 2008-9 and recovery The global economy has experienced, since the second half of 2007, a severe financial crisis that has been reflected in a number of imbalances among which a sharp contraction in global output has been identified (Astley et al, 2009). This sharp fall in output has resulted in... Recession