Question

11. In Donald Trump’s victory speech a few weeks ago, he claimed to pursue massive fiscal-stimulus policies centered on infrastructure spending and tax cuts for both corporations and the workers. Given a current unemployment rate of 4.9% and a projected annual economic growth rate of 2.4% for 2016, do you think the proposed fiscal policy by Trump will benefit the economy? Use an AS-AD diagram to illustrate both the short run and long run effects. (Hint: the estimated natural rate of unemployment is 5% and the potential GDP growth rate is between 2% and 3%)

Answer 1

It is provided that the estimated natural rate of unemployment is 5% and the current level of unemployment is 4.9%. This implies that the economy does not suffer with high unemployment as the current rate is under natural rate of unemployment. WHatever policies be brought in and implemented, this level of unemployment will always exist as these are not related to cyclical but frictional or structural unemployment.

Beside, the economy is also having good growth rate as the current growth rate is in the range of potential growth rate. It implies with given resources, the economy can not have more than this growth rate.

Given the above scenario, if Trump adopted the massive spending and expansionary fiscal policies along with heavy tax cuts then it may bring high inflation to the economy.

With tax cuts along with more massive spending, there will be high increase in AD which will cause the price level rises. In short run, the results will not be prompt. But in long run, such high rise in price will increase inflation and thus decrease the real worth of income. To which the unemployment may further increase.