The recessionary gap in a country is $1 trillion. The spending multiplier is 5. For every $50 billion borrowed, interest rates increase by 0.1 %. For every 0.1% increase in interest rates, investment spending drops by $10 billion. How much should the government spend to bring the economy back to full employment? (Hint: the government must account for the crowding out effect. The fall in investment spending is also subject to the multiplier effect. For example, if investment falls by $10 billion, real GDP will fall by 5 x $10 billion = $50 billion.)
The multiplier in a country is 3. What will be the effect on real GDP if the government cuts taxes by $100 billion if there is no Ricardian equivalence in this society? (Assume there are no distortionary effects from the tax) What will be the effect on real GDP if there is a strong Ricardian equivalence effect?