10. Fiscal policy and investment. Read Focus Box "Deficit Reduction: Good or Bad for Investment?" In each case below, there is a fiscal consolidation. Remember that equilibrium condition in good markets can also be written I= S + (TG) a. How does this fiscal consolidation increase public saving? Calculate the change in public saving and the change in pri- vate saving? What must happen to the target interest rate for this policy to describe the changes in parts a, b, and c? Year Y с Pre-policy 1000 500 Post-policy 950 400 I G 200 300 300 250 b. Year Y с I G Pre-policy 1000 500 200 300 Post-policy 900 450 250 200 T S 200 250 T S 200 200

60 Suppose the government, in an effort to avoid an increase in the deficit, votes for a budget neutral tax cut policy. Assume the marginal propensity to consume (MPC) is equal to 0.85 and taxes are cut by $8 billion. Round answers to the nearest billion, and specify decreases as a negative number. By how much will government spending change? change in government spending: $ What is the resulting change in the equilibrium level of real GDP? change in equilibrium level of real GDP: $ billion

The program has provoked a lot of political discussions. Which of the following statementsare correct (assuming a closed economy)? 1. The higher the marginal propensity to consume, the lower will be investment multiplier.2. A reduction of the tax rate lowers the fiscal policy multiplier.3. The higher the marginal propensity to consume, the more consumption can be induced bymore government spending, and this will lead to a higher fiscal policy multiplier.4. When fiscal policy is not able to compensate fully for other demand reductions, anexpansionary monetary policy can be helpful to overcome a recession more quickly.5. An expansionary monetary policy by the ECB in combination with a fiscal expansion willalways lead to inflation.6. Only a consequent fiscal consolidation will help the economy out of a recession.7. In the liquidity trap there is no crowding-out effect to be expected.8. It is best to conduct fiscal consolidation when the economy is in a boom.

Expansionary fiscal policy include Select one: O a. an increase in net taxes O b. an increase in government spending O c. a decrease in government spending