Question
Assume an economy with lump-sum taxes is hit by a large negative demand shock (e.g. financial crisis). In response, the government introduces a large fiscal
Assume an economy with lump-sum taxes is hit by a large negative demand shock (e.g. financial crisis). In response, the government introduces a large fiscal stimulus package to try and boost economic activity and help stabilize the economy. Assess whether the policy will be successful in each of the following cases:
(a) In the 3-equation model, when stimulus is financed through borrowing
(b) In the 3-equation model, when the stimulus is financed by raising taxes (i.e. a balanced budget expansion)
(c) In the RE PIH model, when the stimulus is financed through borrowing.
In which case will output expand the most? Justify your answer.
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