What are government’s fiscal policy options for ending severe demand-pull inflation? Which of these fiscal options do you think might be favored by a person who wants to preserve the size of government? A person who thinks the public sector is too large? How does the “ratchet effect” affect anti-inflationary fiscal policy?

  1. The economy is in a recession. A congresswoman suggests increasing spending to stimulate aggregate demand but also at the same time raising taxes to pay for the increased spending. Her suggestion to combine higher government expenditures with higher taxes is: LO1
    a. The worst possible combination of tax and expenditure changes.
    b. The best possible combination of tax and expenditure changes.
    c. A mediocre and contradictory combination of tax and expenditure changes.
    d. None of the above.
  2. Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would government spending have to rise to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve the same increase in aggregate demand? Determine one possible combination of government spending increases and tax increases that would accomplish the same goal without changing the amount of outstanding debt.