In a recessionary gap, the economy is operating below its potential output, which can be illustrated through an aggregate supply and aggregate demand graph. This graph typically shows the aggregate demand curve (AD) intersecting with the long-run aggregate supply curve (LRAS) at a point indicating full employment output (Yf). However, in a recessionary situation, the AD curve is to the left of the LRAS curve, representing a lower level of demand in the economy.
Interventionists argue that government action is crucial to help restore long-run equilibrium. Here are some ways interventionists may act:
- Fiscal Policy: The government can increase its spending or cut taxes to boost aggregate demand. For example, investing in infrastructure projects creates jobs and increases consumer spending, thereby shifting the AD curve to the right.
- Monetary Policy: The central bank can lower interest rates, making borrowing cheaper for both consumers and businesses. This increase in consumption and investment also shifts the AD curve to the right.
Through these interventions, aggregate demand increases until it intersects the LRAS at the full employment output level, thereby closing the recessionary gap. The process helps the economy return to a more stable and balanced state.