Question

Identify each of the following as expansionary or contractionary fiscal policy (or neither) and show their effect on the ADAS model.

         a. The corporate income tax rate is increased

         b. Defense spending is increased

         c. The Federal Reserve lowers the target for the federal funds rate

         d. Families are allowed to deduct all their expenses for day care from their federal income taxes

         e. The individual income tax rate is decreased

Answer 1

a. The corporate income tax rate is increased. Taxes are a part of government's fiscal policy. This is a fiscal contraction so aggregate demand is likely to shift to the left.

b. Defense spending is increased. Defense spending is a part of government's fiscal policy. This is a fiscal expansion so aggregate demand is likely to shift to the right.

c. The Federal Reserve lowers the target for the federal funds rate. FFR is a part of Fed's monetary policy. This is a monetary expansion so aggregate demand is likely to shift to the right.

d. Families are allowed to deduct all their expenses for day care from their federal income taxes. This is a fiscal expansion so aggregate demand is likely to shift to the right.

e. The individual income tax rate is decreased. This is a fiscal expansion so aggregate demand is likely to shift to the right.