Question

1. Are increases in both government purchases and net taxes at the same time expansionary or contractionary? Would both changes together increase or decrease the federal government deficit?

Answer 1

If both government purchases and net taxes increase at same time ,the resulting effects can vary depending on whose level of increase is higher .

The government purchases increases money availability in the economy ,people have more money in their hand and so they increase their demand and aggregate demand increases .The taxes on other hand remove money from economy ,so that people have lesser money in their hands and the aggregate demand decrease.

In expansionary policy the net effect of government actions increase money availability in the economy ,so that increase aggregate demand.conversely,the contractionary policy leads to decrease in money availability in the economy ,so that aggregate demand falls.

there can be three possible results if government increase both taxes and spending at same time

(i)the government increasing the spending effects will be greater than increase in net taxes effects,which result in increase in availability of money in the economy thus aggregate demand increases and policy will be expansionary.

(ii)the government spending and net taxes at same the decision in net decreases overall money availability in the economy,thus aggregate demand decrease and policy will be contractionary.

(iii) there can a third situation ,but that doesn't get to see in real world,when net effect doesn't change money availability in the economy. All spending are supplying by taxes.this kind of budget can be seen when an economy is at full employment equilibrium.

same for budget deficit ,if spending increase is more than taxes increase than budget deficit increases ,and taxes increase is more than spending increases then budget deficit will decrease.

but we are not including expectations,if we include expectations of consumers ,firm and investors, then the resulting effects will be different.

when both spending and taxes are increases at same time in budget, the consumer ,firms who are paying taxes ,changes their production and consumption behavior.as expectations theory says consumption depends on both current and future income ,when taxes increase future disposable income also decreases ,so he decrease his consumption much more considering his future requirements . People give more focus on taxes decision rather than spending decision because taxes directly effect their income.so spending increase does not have positive impact on consumer expectations .so the resulting effect will lower availability of money in the economy and lower aggregate demand,and fall in gdp growth and the policy will be contractionary.

Note: i answer considering government purchases all spending except government investment spending .if it includes government investment too,then due to investment multiplier ,income or money increase will be more than spending and so that it will be most likely a expansionary policy.