ECON2542 Intermediate Macroeconomics: Stabilise the Economy



Suppose the economy is initially at labour market equilibrium with stable prices (inflation is zero). Suddenly, pandemic(COVID-19) started and economies went into recession. The government intervened by  using Fiscal policy (FP)  and Monetary policy (MP) to stabilise the economy.

  1. Show  by diagram how a government and central bank could help to stabilise the economy and also discuss each policy impact on the economy.

There are many ways for  the government  to raise money to cover government spending:

  • raise tax  (i.e.  increase income tax or VAT) called ‘tax-financed’
  • sell new bonds (i.e. borrow from households and firms e.g. via pension funds) called  ‘bond or debt-financed’
  1. Explain how ‘tax-financed’and ‘bond or debt-financed’ policies may affect aggregate demand during crisis such as pandemic.
  2. How worrying is the increases in government deficits and debt?


  1. Assume that a household has access to credit. What is the impact on long run consumption if household is expected promotion to a senior position? What would be the impact if promotion was unexpected?
  2. Why do savers households not lend directly to borrower households? How can banks help solve this problem?

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