Note: If a government maintains a balanced budget, this implies that total government expenditure G is financed from government taxes T. Hence G = T and there is no government budget deficit or surplus.

a)

Assume that Autaria's government has a balanced budget initially but there is no law that requires the government to maintain a balanced budget at all times. Assume further that the government cuts taxes temporarily. This leaves Autaria's government with a government budget deficit (G > T or G T > 0), that it must somehow finance. Suppose people think the government will finance its deficit by printing extra money it now needs to cover its expenditures. What is the overall effect of the above on aggregate output in the short-run? Does the domestic currency appreciate or depreciate against the foreign currency in the short-run? How does this compare with a hypothetical case where there is a temporary decrease in taxes, keeping all other variables constant? Explain with the help of a figure