3. In Country X, GDP is $400B below the full-employment level of output. Government officials have measured the marginal propensity to consume at 0.75.
A. The government wants to use fiscal policy to bring the economy back to full employment.
I. If the government wants to achieve this through a change in spending, what change would be necessary? (8 points)
II. If the government wants to achieve this through a change in taxes, what change would be necessary? (8 points)
III. If the government wants to achieve this without creating a budget deficit, what change would be necessary? (8 points)
B. Say that for a variety of reasons, the government shows that it is not up to the task of conducting fiscal policy. The central bank steps up and does something about it. If a 1% decrease in interest rates leads to an increase in investment of $50B, how should the central bank's interest rate targets change? (13 points)
3. In Country X, GDP is $400B below the full-employment level of output. Government officials have measured the marginal propensity to consume at 0.75.
A. The government wants to use fiscal policy to bring the economy back to full employment.
I. If the government wants to achieve this through a change in spending, what change would be necessary? (8 points)
II. If the government wants to achieve this through a change in taxes, what change would be necessary? (8 points)
III. If the government wants to achieve this without creating a budget deficit, what change would be necessary? (8 points)
B. Say that for a variety of reasons, the government shows that it is not up to the task of conducting fiscal policy. The central bank steps up and does something about it. If a 1% decrease in interest rates leads to an increase in investment of $50B, how should the central bank's interest rate targets change? (13 points)
