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Suppose the economy is in recession. Policymakers estimate that the aggregate demand is $100 billion short of the amount necessary to generate the long-run natural
Suppose the economy is in recession. Policymakers estimate that the aggregate demand is $100 billion short of the amount necessary to generate the long-run natural rate of output. a) If the government chooses to use fiscal policy to stabilise the economy, by how much should it increase government spending if the marginal propensity to consume is 0.75 and there is no crowding out? b) If there is crowding out, will the government have to spend more or less than the amount you found in part (a) above? Why? c) If investment is elastic to changes in interest rate, is crowding out more of a problem or less of a problem? Why? d) If policymakers discover that the lag for fiscal policy is two years, should that make them more likely to use fiscal policy as a stabilisation tool or more likely to allow the economy to adjust on its own? Why? e) Explain the impact automatic stabilisers would have on an economy whose aggregate demand is below the long-run natural rate of output
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