2. Assume that the US economy is in a recessionary gap, as in at the end of the 2008 Financial Crisis. Furthermore, assume that only fiscal policy is at your disposal [because the Fed has already taken the full extent of accommodating monetary policy:dropping interest rates down to 0 and implementing multiple rounds of quantitative easing].

The Council of Economic Advisers estimates that the marginal propensity to consume is 0.8. a.Assume there is a recessionary gap, and that the government needs to increase aggregate expenditure (at the current price level) by $2,000 billion, to bring the economy back to long-run equilibrium. Using the simple version of the government spending multiplier, how much should government spending increase by? If you were to make the government spending multiplier one step more realistic

and include the interest-rate effect, how would this change your answer?

b. If instead, the government was not able to pass any new legislation to increase government spending, describe how the economy would naturally adjust in the long run, using the sticky price theory. Use an AD/AS diagram, with the economy initially in a

recessionary gap, labeling this point as ESR.