Question

Identify the least amount the government could spend to get the economy back to full employment. Show your work

Answer 1

If a government wants to fix a recession or dial back an expansion, its concrete goals would be to return the economy to full employment, or to control inflation. Fiscal Policy can help them in achieve their goals.

The tools of fiscal policy are government spending and taxes. They are, If u want to expand an economy that is producing too little, so expansionary fiscal policy is used to close negative output gaps or recessions. Expansionary fiscal policy includes either government spending or decreasing taxes.

An economy that is producing too much needs to be contracted. In that case Contractionary fiscal policy is the correct choice (either decreasing government spending or increasing taxes).

Example :- There are two economies, one is A and the other is B.

Government spending directly affects Aggregate demand,  Taxes indirectly affect Aggregate demand

If A is experiencing a recession the government might give everyone a tax refund(expansionary fiscal policy). Here, the tax refund leads to an increase in disposable income, an increase in disposable income causes an increase in consumption, the increase in consumption leads to an increase in aggregate demand, an increase in aggregate demand leads to an increase in output and a decrease in unemployment and the side effects of this will increase the Inflation.

B is also experiencing a boom and inflation. They cut government spending, the cut in the government spending leads to a decrease in aggregate demand, because the government spending is a component of aggregate demand. The decrease, In aggregate demand leads to a decrease in output because the decrease in aggregate demand will leads to a new short run equilibrium with a lower output, higher unemployment rate and a lower price level.

The tax multiplier is always less than the spending multiplier because some of that amount is saved and not spent in the beginning.

When a gap is negative , you want output to get bigger and so expansionary fiscal policy is the right choice. When a gap is positive you want output to get smaller and so contractionary fiscal policy is the right choice. Once you decide the type of policy, you can then decide on which tool to use. Policy makers have to be careful to mind the gap. If they want to close an output gap they need to know how much stimulus is necessary. Too much stimulus and you may cause a different kind of gap.

there are different kind of lags that can complicate the fiscal policy in The real world they are as follows:

1) Data lag

2) Recognition lag

3) Decision lag

4) Implentation lag

size of the tax cut needed = size of the gap / tax multiplier

size of the government spending needed = size of the gap / spending multiplier..

The above given are the some of the details regarding the getting back an economy to the normal stage.