Suppose the economy is in recession. Policymakers estimate that aggregate demand is $100 billion short of the amount necessary to generate the long run natural rate of output. That is, if aggregate demand were shifted to the right by $100 billion, the economy would be in long run equilibrium. a.Explain the impact on the economy if the government chooses to use fiscal policy to stabilize the economy and the marginal propensity to consume (MPC) is given as 0.75 with no crowding out. b.If there is a crowding out effect and investment is very sensitive to changes in the interest rate, should the government increase spending more or less than this amount?
Suppose the economy is in recession. Policymakers estimate that aggregate demand is $100 billion short of the amount necessary to generate the long run natural rate of output. That is, if aggregate demand were shifted to the right by $100 billion, the economy would be in long run equilibrium. a.Explain the impact on the economy if the government chooses to use fiscal policy to stabilize the economy and the marginal propensity to consume (MPC) is given as 0.75 with no crowding out. b.If there is a crowding out effect and investment is very sensitive to changes in the interest rate, should the government increase spending more or less than this amount?
Chapter21: Fiscal Policy
Section: Chapter Questions
Problem 3SQP
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Suppose the economy is in recession. Policymakers estimate that aggregate demand is $100 billion short of the amount necessary to generate the long run natural rate of output. That is, if aggregate demand were shifted to the right by $100 billion, the economy would be in long run equilibrium.
a.Explain the impact on the economy if the government chooses to use fiscal policy to stabilize the economy and the marginal propensity to consume (MPC) is given as 0.75 with no crowding out.
b.If there is a crowding out effect and investment is very sensitive to changes in the interest rate, should the government increase spending more or less than this amount?
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