Question:
Currently, a government's budget is balanced. The marginal propensity to consume is 0.80. The government has determined that each additional $10 billion it borrows to finance a budget deficit pushes up the market interest rate by 0.1 percentage point. It has also determined that every 0.1-percentage-point change in the market interest rate generates a change in planned investment expenditures equal to $2 billion. Finally, the government knows that to close a recessionary gap and take into account the resulting change in the price level, it must generate a net rightward shift in the aggregate demand curve equal to $200 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase its expenditures?