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Asked Mar 4, 2020
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If the president and parliament agree on a policy to reduce the budget deficit by increasing taxes while holding government spending constant, what impact will this fiscal contraction policy have on output and interest rates?

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Expert Answer

Step 1

The budget is a financial plan for a specific period of time which is usually for a financial year. In the financial plan, the expected revenue to the government and the anticipated expenditure of the government will be included. When the revenue and expenditure are equal, the budget is known as the balanced budget and when the revenue exceeds the expenditure, there will be budget surplus and when the expenditure exceeds revenue, it will lead to the budget deficit.

Step 2

The budget deficit in the economy indicates that the revenue of the government lags behind the expenditure. When the government decides to increase the revenue by increasing the tax rates, it will have multiplier time’s decrease in the spending pattern of the people. The increased tax decrease...

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