Macroeconomic equilibrium is desirable for two reasons:The temporary

Macroeconomic PolicyStabilization policy is the use of government policy to reduce the severity of recessions and rein in excessively strong expansions.Policy in the Face of Demand Shocksi.   Monetary and fiscal policy shifts the aggregate demand curve. If the economy experiences a negative demand shock, if policy makers react quickly to the fall in aggregate demand, they can use monetary or fiscal policy to shift the aggregate demand curve back to the right.ii.   A policy that short-circuits the adjustment and maintains the economy at its original equilibrium is desirable for two reasons:The temporary fall in aggregate output that would happen without policy intervention is a bad thing, particularly because such a decline is associated with high unemployment.Price stability is generally regarded as a desirable goal. So preventing deflation (fall in aggregate price level) is desirable.Any short run gains from an inflationary gap must be paid back later. Policy makers usually try to offset positive as well as negative demand shocks.Responding to Supply Shocksi.   In contrast to the case of a demand shock, there are no easy remedies for a supply shock.ii.   If you consider using monetary of fiscal policy to shift the aggregate demand curve in response to a supply shock, the right response isn’t obvious. Two bad things are happening simultaneously: a fall in aggregate output, leading to a rise in unemployment, and a rise in the aggregate price level.Any policy that shifts the aggregate demand curve helps one problem only by making the other worse.If government acts to increase aggregate demand and limit the rise in unemployment, it reduces the decline in output but cause even more inflation. If it acts to reduce aggregate demand, it curbs inflation but causes a further rise in unemployment.Fiscal Policy: The BasicsTaxes, Government Purchases of Goods and Services, Transfers, and Borrowingi.   Government spending consists of purchases of goods and servicesAmmunition for the military, salaries of public schoolteachersOther goods and servicesState and local spending on variety, police and firefighters, highway construction and maintenance.ii.   Government spending also on transfersPayments by the government to households for which no good or service is provided.Social security, which provides guaranteed income to older Americans, disabled Americans, and the surviving spouses and dependent children of deceased beneficiariesMedicare, which covers much of the cost of health care for Americans over 65Medicaid, which cover much of the cost of health care for Americans with low incomes.iii.      Social insurance is government programs that are intended to protect families against economic hardship.The Government Budget and Total Spendingi.   GDP = C + I + G + X –IMii.   Government directly controls G, government purchases of goods and services.iii.   Through changes in taxes and transfers, it also influences consumer spending, C, and in some cases investment spending, I.Disposable income, the total income households have available to spend, is equal to the total income they receive from wages, dividends, interest, and rent, minus taxes, plus government transfer. So either an increase in taxes or a decrease in government transfers reduces disposable income. A fall in disposable income leads to a fall in consumer spending.Conversely, either a decrease in taxes or an increase in government transfers increases disposable income, and a rise in disposable income leads to a rise in consumer spending.iv.   Because the government itself is one source of spending in the economy, and because taxes and transfers can affect spending by consumers and firms, the government can use changes in taxes or government spending to shift the aggregate demand curve.Expansionary and Contractionary Fiscal Policyi.   The government would want to shift the aggregate demand curve to close either a recessionary gap, created when aggregate output falls below potential output, or an inflationary gap, created when aggregate output exceeds potential output.ii.   Fiscal policy that increases aggregate demand, called expansionary fiscal policy, normally takes one of three forms:An increase in government purchase of goods and servicesA cut in taxesAn increase in government transfers.iii.   Fiscal policy that reduces aggregate demand, called contractionary fiscal policy, is the opposite of expansionary fiscal policyA reduction in government purchases of goods and servicesAn increase in taxesA reduction in government transfers