The government of country A only relies on lump-sum taxes to finance its expenditures, and is evaluating a fiscal consolidation plan to decrease its fiscal deficit. Two alternatives are being assessed: increasing current taxes, or cutting current government expenditures. In this problem, you will analyse both alternatives through the lens of the Real Business Cycle (RBC) model

Now suppose that the government increases current taxes, and cuts current government spending. What are the effects of the tax change on the real wage, employment, the real interest rate, and output? Explain by using the equilibrium diagrams for the current labour market and for the current goods market in the RBC model.