In 2015, the U.S. federal government increased government spending (G) by $56 bi

Question

In 2015, the U.S. federal government increased government spending (G) by $56 billion. This question has you both illustrate and explain the short- and long-run effects of these fiscal adjustments.

(a) Using the short-run model, show the impact of increased government spending on the inflation rate and short-run output.

(b) On the diagram(s) above, show how the central bank would respond to the increase in government spending.

(c) In terms of the short run model, how did the increase in G impact the other components of spending (C, I, and NX)?

(d) In terms of the basic growth (Solow) model, what does the increase in G mean for eoconomic growth? Be clear.

Explanation / Answer

.

An increment in Government spending will increase the equilibrium price level, as a result inflation rates also raise. Therefore short run output increases.

b.

Central bank will increase the bank rate, and decrease money supply in economy which would reduce high demand.

c.

Investment will reduce as central bank increases interest rates to decrease money supply.

Net exports would reduce sue to more imports into the country.

d.

More the G, economic growth would be high.

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