In: Economics
describe the fiscal policy remedies that a Keynesian economist might prescribe to close a recessionary gap. What impact would these policy changes have on the federal budget deficit and the public debt?
Ans. In a recessionary phase,
government must use the fiscal expansionary policy. So, either it
can increase government spending or can cut taxes. Both these
policies will increase household spending. Although due to increase
in household income, transaction demand for money will rise
increasing the interest rate at given level of money supply which
will increase cost if borrowing decreasing investment spending and
also, increased interest rate will lead to decrease in met capital
outflow appreciating the domestic currency and hence, decreasing
net exports. This will decrease the aggregate demand and the fiscal
policy won't be able to have the same effect. But the aggregate
demand for goods and services will increase leading to rightward
shift of aggregate demand curve from AD to AD'. This will lead to
increase in price level from P to P' and output from Y to Y' at
given aggregate supply.
Budget Deficit = Government Expenditure- Tax Revenue
So, increase in government expenditure and decrease in taxes will increase government's budget deficit and hence, increase pubic debt.
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