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Suppose that you are a member of the Council of Economic Advisers. The president has asked you to prepare a statement on the question, “What is the proper fiscal policy for the next twelve months?” Prepare such a statement, indicating (a) the current state of the economy (that is, the unemployment rate, growth in real income, and rate of inflation) and (b) your fiscal policy suggestions. Should the budget be in balance? Explain the reasoning behind your suggestions.

BuyFind

Macroeconomics: Private and Public...

16th Edition
James D. Gwartney + 3 others
Publisher: Cengage Learning
ISBN: 9781305506756
BuyFind

Macroeconomics: Private and Public...

16th Edition
James D. Gwartney + 3 others
Publisher: Cengage Learning
ISBN: 9781305506756

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Chapter
Section
Chapter 12, Problem 1CQ
Textbook Problem

Suppose that you are a member of the Council of Economic Advisers. The president has asked you to prepare a statement on the question, “What is the proper fiscal policy for the next twelve months?” Prepare such a statement, indicating (a) the current state of the economy (that is, the unemployment rate, growth in real income, and rate of inflation) and (b) your fiscal policy suggestions. Should the budget be in balance? Explain the reasoning behind your suggestions.

Expert Solution
To determine

Fiscal policy measures in the current economy.

Explanation of Solution

For discretionary fiscal policy, there will be a problem of appropriate timing which may fail to provide desired result. Hence, the automatic stabilizers like unemployment compensation, corporate profit tax, and progressive income tax will be suitable fiscal policy measure for the next twelve months. 

When the economy is in recession, the automatic stabilizers increases the government expenditure (spending) and reduces taxes. Alternatively, when there is an economic boom, these stabilizers reduce the government expenditure (spending) and increase the taxes.

These automatic stabilizers enlarge the budget deficit of the government. This increases the aggregate demand and it will increase the employment rate, real GDP, and balanced inflation rate.  Keynes believed in counter-cyclical fiscal policy to offset the fluctuations in the economy, rather than the balanced budget.

Economics Concept Introduction

Discretionary fiscal policy: Discretionary fiscal policy refers to the change in government spending and taxes in order to achieve economic goals.

 Automatic stabilizers: Automatic stabilizers are changes in fiscal policy that varies the aggregate demand during fluctuations in business cycle without the need for explicit action by policymakers.

Countercyclical fiscal policy: counter cyclical fiscal policy is an automatic action which operates in opposite direction from the fluctuations in business cycle through changes in government spending and tax revenue

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