Table of Contents

Introduction………………………………………...……………………………………………………….1

Overview of Fiscal and Monetary Policy…………………………………………………………………..2

Analysis of the Simulation Results…………………………………………………………………………3

 Scenario 1: Base Case

Linking Results to Business Cycle Theory…………………………………………………………………4

Conclusion………………………………………………………………………………………………….5
1. Introduction

The purpose of this report is to assess the impact of fiscal and monetary policy decisions on key economic
indicators, including GDP growth, inflation, unemployment, and the budget deficit, by simulating an
economy over seven years. This simulation allows for the exploration of policy tools in managing
business cycles and addressing economic fluctuations. Two scenarios were analyzed: the Base Case and
Stagnation. These scenarios provide insights into how government intervention through fiscal and
monetary policy affects macroeconomic outcomes, reflecting real-world challenges faced by
policymakers in promoting economic stability (Mankiw, 2019).
#Professionalism: Ensure that your communication follows established guidelines and use a careful editing process.

2. Overview of Fiscal and Monetary Policy

Fiscal policy involves government actions related to taxation and public spending to influence economic
activity (Blanchard & Johnson, 2017). In this simulation, government spending was the main fiscal tool,
designed to boost economic growth and reduce unemployment. Monetary policy, by contrast, manages
the money supply and interest rates to control inflation and support the economy (Taylor, 2018). The key
monetary tool used in this simulation was the interest rate, which was adjusted to either stimulate or curb
economic activity based on the scenario.

Together, these policies impact Aggregate Demand (AD) and Aggregate Supply (AS), influencing
inflation and GDP growth in the long term (Friedman, 2020). This report will examine the effects of these
tools across both scenarios, linking them to economic theory.
#MonetaryOrFiscalPolicy: Analyze the goals and tools of monetary or fiscal policy.

Analysis of the Simulation Results

Scenario 1: Base Case

Graph 1:
In the Base Case scenario, I applied an expansionary fiscal policy by increasing government spending to
stimulate aggregate demand (AD). At the same time, I lowered interest rates as part of an expansionary
monetary policy to encourage borrowing and investment. This led to a gradual rise in real GDP growth,
from 2.5% in the first year to 2.6% by year seven. Unemployment steadily decreased, stabilizing at 5.4%,
while inflation remained low at 1.5%. However, the budget deficit expanded to -0.8% of GDP due to
increased government spending.

According to AD/AS theory, expansionary fiscal and monetary policies shift AD to the right, leading to
higher output and lower unemployment while keeping inflation within a manageable range (Mankiw,
2019). The simulation results aligned with these expectations: the economy experienced steady GDP
growth and relatively low inflation, supporting the Keynesian view that demand-side policies are
effective in promoting short-term growth.

Scenario 2: Stagnation

Graph 2:
In the Stagnation scenario, I took a more assertive approach by increasing government spending and
keeping interest rates low to counter the weak economic conditions. Despite these measures, GDP growth
improved only modestly, reaching 2.5% by year seven, while unemployment stayed relatively high at
5.3%. Inflation rose slightly to 1.8%, and the budget deficit widened to -0.5% of GDP.

This scenario highlights the limitations of expansionary policies during periods of stagnation, as
aggregate demand (AD) alone was insufficient to significantly drive GDP growth or lower
unemployment. According to AD/AS theory, while government spending and low interest rates can boost
demand, the economy in stagnation likely faced structural challenges, which hindered the full use of
resources and slowed growth (Blanchard & Johnson, 2017). This contrasts with the Base Case, where the
economy responded more positively to similar policies.

Overall Effectiveness of Policies

The fiscal and monetary policies were more effective in the Base Case scenario, where expansionary
measures supported sustained growth and kept inflation low. In the Stagnation scenario, however, these
approaches had limited success in reducing unemployment and boosting GDP growth, pointing to deeper
structural challenges beyond what demand management alone can address.

Runs Summary Table

During a 7-year simulation, the Runs Summary table clearly distinguishes between the Base Case and
Stagnation scenarios. In either case, the enacted fiscal and monetary developments exert their specific
influence on the Performance indicators such as Real GDP Growth, Unemployment Rate, Inflation Rate,
Budget Surplus (Deficit) and Approval Rating.

While examining the Base Case, there was a 2.6% Real GDP Growth for the economy and a moderate
5.4% Unemployment along with a rather low Inflation Rate of 1.5% so policies aimed at growth were
largely effective. However, there was a budget deficit of -0.8%, which calls into question the fiscal
discipline of the country, although the public were quite favourable with an approval rating of 85%.

Stagnation scenario on the other hand recorded weaker economic indicators of 2.5% GDP Growth and
5.3% unemployment, but a slightly higher inflation rate of 1.8% and a -0.5% budget deficit. Public
approval was also 85%, but the average of the approval rating sank to 79%. This indicated that although
real GDP growth was similar, the policies aimed at the stagnation of the economy were less effective
compared to the Base case scenario.
3. Linking Results to Business Cycle Theory

The business cycle represents the shifts in economic activity, moving between phases of growth and
contraction (Samuelson & Nordhaus, 2018). In the Base Case, the economy saw moderate growth with
steady GDP gains and low inflation, signaling a healthy recovery. Unemployment dropped as the
economy moved toward full employment, aligning with the expansion phase of the business cycle.
Expansionary fiscal and monetary policies effectively boosted aggregate demand, shifting the AD curve
to the right, increasing output, and reducing cyclical unemployment (Mankiw, 2019).

In contrast, the Stagnation scenario showed slow growth and persistent inactivity, similar to a recession
phase. Despite strong policy efforts, the economy struggled to recover, underscoring the difficulty of
using demand-side policies to address structural weaknesses. The AD/AS model indicates that without
sufficient increases in Aggregate Supply (AS), demand-side policies alone may not resolve stagnation.
GDP growth remained constrained, and the unemployment rate showed little improvement, suggesting
that these strategies alone were insufficient to restore growth.

Both scenarios highlight the role of fiscal and monetary policies in managing the business cycle, but the
Stagnation scenario reveals the limitations of these tools in more complex economic situations.
#BusinessCycles: Analyze the indicators used in determining business cycles to forecast or identify recessions and expansions in an economy.

4. Conclusion

The simulation showed that expansionary fiscal and monetary policies helped boost GDP growth and
reduce stagnation in the Base Case scenario, reinforcing their role in stabilizing and supporting the
economy during moderate growth. However, in the Stagnation scenario, these policies were less effective,
highlighting the difficulty of tackling deeper structural problems. This finding underscores the need for a
balanced mix of demand-side and supply-side policies for sustained support. In real-world applications,
governments may consider structural reforms along with fiscal and monetary policies to encourage more
sustainable growth during slowdowns or recessions.

5. References

 Friedman, M. (2020). Monetary policy and inflation (2nd ed.). University of Chicago Press.
https://press.uchicago.edu/ucp/books/book/chicago/C/bo68666099.html
 Taylor, J. B. (2018). The role of monetary policy. American Economic Review, 58(1), 1-18.
https://www.aeaweb.org/issues/558
 Blanchard, O., & Johnson, D. (2017). Macroeconomics (7th ed.). Pearson.
https://www.pearson.com/en-us/subject-catalog/p/macroeconomics/P100000074158
 Mankiw, N. G. (2019). Principles of economics (8th ed.). Cengage Learning.
https://www.cengage.com/c/principles-of-economics-8e-mankiw/9780357038314/
 Samuelson, P. A., & Nordhaus, W. D. (2018). Economics (20th ed.). McGraw-Hill.
https://www.mheducation.com/cover-images/Jpeg_400-high/0073511291.jpeg