EXERCISE 14.8STIMULUS WITHOUT MORE DEBT

Read'Stimulus, Without More Debt'by Robert Shiller.

https://www.nytimes.com/2010/12/26/business/26view.html

Assume the economy is in a recession. The government has a high level of debt and wants to set a balanced budget, that is,G=T. How can the government achieve a fiscal stimulus effect on GDP whilst keeping the budget balanced?

To answer the question, take the following steps:

• Show how this is possible in a multiplier diagram, ensuring that you label the relevant intercepts and angles. Make the diagram sufficiently accurate so that the exact size of the multiplier is visible.
• Explain in words how the government can achieve such a fiscal stimulus effect whilst keeping the budget balanced.
• Derive the balanced budget multiplier using algebra. (Hint: You will need to write down expressions for the change in GDP associated with a change in bothGandTand set these equal to each other.)
• Comment briefly on any disadvantages you see with the use of this balanced budget fiscal stimulus.

You can make the following assumptions:

• Assume a lump sum tax. This means that the tax does not depend on the level of income,T=T, rather than our usual assumption thatT=tY.
• Also assume that the country does not have any imports or exports.