a) Suppose that GDP is $200 billion below its potential level. It is expected th

Question

a) Suppose that GDP is $200 billion below its potential level. It is expected that next-period GDP will be
back at its potential level. You are told that the multiplier for government spending is 2 and that the effects of
the government spending are immediate. What policy actions can be taken to put GDP back on target (potential
level) in the current period?
b) The basic facts about the path of GDP are as in section a. But there is now a one-period outside lag for
government spending. The multiplier for government spending is still 2 in the period that the spending takes
place. What is the best that can be done to keep GDP as close to target as possible in the current period?
c) Now suppose that you knew that the multiplier for government spending was between 2 and 5 but that its
effects ended in the period in which spending was increased. How would you run fiscal policy if GDP would,
without policy, behave as in section a?

Explanation / Answer

(A)- If current GDP is less than Potential GDP by $200 billion and if goverment spending multiplier is 2 then goverment spending will increases by $100 billion in current period policy to reaching the potential output.

(B)-if in the problem given that is one-period outside lag for goverment spending then nothing policy can be done to close the current GDP gap but in the next period goverment should be decide to spend more than $100 billion. to gaining its original level.

(C)- if the effect has ended then there will not taken fiscal policy by goverment.

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