How to solve answer this for full points?? FRED 3060 2.500 2007 20:2 2015 Figure

Question

How to solve answer this for full points?? FRED 3060 2.500 2007 20:2 2015 Figure 8: Solid Line, Left Scale : Output Gap, percent of Potential GDP Dashed Line, Right Scale: Real US Government Expenditures and Investment, in dollars 12. In the figure above, we see that the during the recession of 2008, the output gap (solid line) grew to almost 6% of GDP, and did not fall to under 1% of GDP until 2015, Explain whether fiscal policy (the dashed line) was counter-cyclical, or pro-cyclical, during the time period shown. Explain your answer, and justify whether or not you think the fiscal policy carried out was appropriate. 10 points

Explanation / Answer

Output gap refers to the gap or difference between actual GDP and Potetial GDP . Here we can see that before 2008 there was positive output gap or actual GDP was greater than potential . This is the period of inflation or boom .

But since 2008 the scenario changed , the output gap became negative or there was recession . If a fiscal policy makes the business cycle condition worse by adding stimulus during a boom or adding more austerity during a recession then it is procyclical .

But if a policy moderates the cycle then it is countercyclical in nature . Here the fiscal policy was pro cyclical in nature . Due to this policy the recession slowly gained momentum and widened after 2008 . It could not moderate it . Hence it was not appropriate .

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