Lets imagine you want to reduce the public debt to gdp ratio (D/Y). What is the...

Lets imagine you want to reduce the public debt to gdp ratio (D/Y). What is the best method:

reducing govt. spending, increasing taxes, printing money or increasing potential output?

Explain your answer

Solutions

Expert Solution

Reducing government spending will reduce aggregate demand in the economy which will reduce the price as well as output level in the economy from P to P1 and Y to Y1 respectively.

Increasing taxes will reduce the disposable income which will reduce consumption and aggregate demand in the economy. It will reduce the price as well as output level in the economy from P to P1 and Y to Y1 respectively.

Pricinting money will shift the LM curve to its right from LM to LM1 which will reduce the rate of interest from "i" to "i1" and output level rises from "Y" to "Y1".

All of the methods have one or more weaknesses where one of the method reduces the real GDP while other raises it at the cost inflation. We can adopt mixture of these rather than adopting one of them where they do ot affect real GDP at all. If still we wants to raise decide a better policy, we can print money and pay all of our debts and reduce the debt / GDP ratio.

Rahul Sunny answered 1 year ago

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