Consider the following macroeconomic statistics. Absent of any fiscal policy intervention. Year Potential GDP Real GDP Price Level 2021 $1.5 trillion $1.5 trillion 150 2022 $1.4 trillion $1.3 trillion 148 The government decides to use fiscal policy to maintain real GDP at its potential level (in 2022). Which of the following is an appropriate policy response? Balance the budget Decrease interest rate Decrease goverment purchases Decrease transfer payments Decrease taxes
Question
Consider the following macroeconomic statistics. Absent of any fiscal policy intervention. Year Potential GDP Real GDP Price Level 2021 1.5 trillion 150 2022 1.3 trillion 148 The government decides to use fiscal policy to maintain real GDP at its potential level (in 2022). Which of the following is an appropriate policy response?
Balance the budget
Decrease interest rate
Decrease goverment purchases
Decrease transfer payments
Decrease taxes
Solution
The appropriate policy response would be to decrease taxes.
Here's why:
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The potential GDP in 2022 is 1.3 trillion. This indicates that the economy is in a recessionary gap, where the real GDP is less than the potential GDP.
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In such a situation, the government can use expansionary fiscal policy to increase the aggregate demand and bring the economy back to its potential level.
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Expansionary fiscal policy can be implemented through an increase in government spending, a decrease in taxes, or a combination of both.
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Decreasing taxes would increase disposable income for households, which would lead to an increase in consumption spending. This increase in consumption would then lead to an increase in aggregate demand, which would help to close the recessionary gap.
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Therefore, the appropriate policy response in this situation would be to decrease taxes.
Note: Decreasing interest rates is a monetary policy tool, not a fiscal policy tool. It is used by the central bank, not the government.
Similar Questions
Consider the hypothetical information in the following table for potential GDP, real GDP and the price level in 2013 and in 2014 if the government does not use fiscal policy. Year Potential GDP Real GDP Price Level 2013 $1.5 trillion $1.5 trillion 150 2014 $1.7 trillion $1.6 trillion 152 If the government wants to use fiscal policy to keep real GDP at its potential level in 2014, it should: increase interest rates. decrease transfer payments. decrease interest rates. decrease government purchases. decrease income taxes.
A decline in aggregate demand has caused a recession. The economy’s current level of real GDP is below its long-run equilibrium and the current price level is below the equilibrium price level. a. Without government action, the economy will return to long-run equilibrium through multiple choice 1a decrease in aggregate supply.a decrease in long-run aggregate supply.an increase in aggregate supply.an increase in long-run aggregate supply. b. If the government implements expansionary fiscal policy after the economy has self-corrected, the increase in aggregate demand will multiple choice 2decrease both real GDP and the price level.increase both real GDP and the price level.decrease real GDP and increase the price level.increase real GDP and decrease the price level. c. The slow fiscal policy will result in multiple choice 3low interest rates.high unemployment.demand-pull inflation.cost-push inflation.
FISCAL POLICY
Suppose that the federal budget is balanced when GDP is at potential GDP. If equilibrium GDP falls below potential, please explain how and why government transfer payments would change; how and why tax receipts would change; how and why the budget would change.
Which type of policy does the governments adopt to increase the aggregate demand in the economy?Contractionary fiscal policyExpansionary fiscal policyTight monetary policyLoose monetary policy
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