Suppose that it is December 2016 and you are called to Washington to audition for a cabinet-level post in the next administration and to advise him or her on the proper size of the economic stimulus program.
Your forecast is that, were 2018 to be a normal business-cycle time, that the level of real GDP in 2018 would be $17.0 trillion/year. You are conducting your analysis in the income-expenditure framework where: Y = C + I + G + X , C = co + cy(Y - T). You believe that cy = 0.5.
You project that there will be little change from trend in consumer confidence co, which you project at $2.5 trillion/year in 2018. you project that business demand for investment spending will be $3.5 trillion/year in 2018. You project that exports will be $2 trillion/year in 2018. And you project that the Federal Reserve will not take additional steps to stimulate the economy.
- What level of government purchases spending G do you recommend for 2018? Explain why?
- Suppose that the President-Elect’s political advisors say that it is very important, politically, to cut government spending. What do you say in response?
- Suppose that the collapse of the euro suddenly drives up interest rate spreads, and leads you to forecast that I in 2018 will be not $3.5 trillion but $2.5 trillion. How do you change your recommendation for G?