The estimated potential real GDP is approximately $14 trillion and the current r

Question

The estimated potential real GDP is approximately $14 trillion and the current real GDP is approximately $12.5 trillion. In the current political mood in the U.S. there has been increased discussion on implementing a middle class tax cut as one policy option to stimulate the economy. Given this policy initiative and the marginal savings rate for U.S. households which is approximately 5.5% compute and illustrate the estimated value of a middle class tax cut that would be necessary to eliminate the recessionary gap.

Explanation / Answer

Ans

Mps = 1(5.5%)=0.055

Mpc= 1-0.055=0.945

Tax multiplier = - mpc/1-mpc=17.18

So tax cut needed=14-12.5/17.8= 0.09 trillion

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