Question

The Federal Government distributed a recovery relief fund to all households with $600 for all individuals filing and $1,200 for all households filing jointly and $500 for each children in each household. This was part of the $2.2 Trillion stimulus package under CARES Act of March 2020 that also included employee job protection plan for small business owners and restaurants, travel related businesses, unemployment insurances and households with no taxes filed. What would be the overall impact on AD of this recovery relief fund caused by COVID19 public health crisis and its effect on change in real GDP? Assume that the Marginal Propensity to Consume (MPC) for all American consumers is 0.8 in March 2020. Explain your answer briefly as well in your own words. Make sure you use your understanding of the concept of expenditure multiplier in estimating this problem

Answer 1

So the Federal government has issued a fiscal stimulus worth 2.2 trillion dollars. This means that government spending has increased by about 2.2 trillion dollars. An increase in government spending will increase aggregate spending by the amount of G - 2.2 trillion. As aggregate spending increases, it implies a equivalent increase in aggregate demand. So AD curve will shift to the right causing price level to rise while GDP increases as well based on the multiplier effect of the fiscal stimulus.

The multiplier is given by 1/1-mpc. As mpc=0.8, the multiplier value is 1/0.2 = 5. So a fiscal stimulus of 2.2 trillion will increase GDP by multiplier*fiscal stimulus value. So gdp increases by 11 trillion dollars due to the multiplier effect. This multiplier effect occurs because the fiscal stimulus from the government, increasess consumption in the consequent periods, which leads to higher increase in real GDP.