Supposing the status quo of the United States today states that: there is no real unemployment, the consumer price index is rising at 2 percent annually, and the federal government budget deficit, 200 billion dollars, is equal to 5 percent of the gross national product. Now, the question is how and what changes will result from fiscal and monetary policy.
For example, if legislation has just passed which holds government spending constant and raises personal income taxes enough to balance the budget, then obviously the deficit would cease growing, as mentioned, along with other fluctuations of the gross national product as a whole. Because the government will stop borrowing money, it will also cut down on the
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The surge in the money supply will not only up the multiplier, but will hopefully lead to a balanced budget multiplier. The Fed intends to do this by matching the change in government spending with an equivalent change in taxes. With more money circulating amongst the banks, and eventually the people, the dollar will soon depreciate in value or in other words: inflation. Furthermore, being that the interest rates are negatively related to the rising price line (inflation), consumption will increase, and so will investment, because there will be more incentive to borrow, and therefore buy houses, or advance in technology through resource and development, meaning a balance or increase in output and/or employment.. Moreover, the new exchange rate also encourages export, which will theoretically accomplish the government goal of managing a good economy while decreasing spending and paying off the deficit. Since there is usually a six month period between the time legislation is passed, and the time that the results become visible, the government and the Fed should allow approximately a year to stabilize the economy. However, that’s only assuming that the central bank implements their policies at the correct time. To cite an example, suppose that the President announces to pay off the deficit with an immediate tax hike in