Describe the status of cyclically adjusted budget

Question

Assume the full-employment, non-inflationary level of real output is GDP₃ (not GDP₂). If the economy is operating at GDP2 instead of GDP₃, describe the status of its cyclically adjusted budget? The status of its present fiscal policy? What change in fiscal policy would you suggested? How would you achieve that in terms of the G and T lines in the figure?

Answer 1

If full-employment GDP level was GDP₃, then the standardize budget is contractionary as a surplus would present.  Even though the “actual” budget has no deficit at GDP₂, fiscal policy is contractionary.  To move the economy to full-employment, government must cut taxes or enhance spending.  You would increase G line or lower T line or combination of each yet they intersect at GDP₃.