Question

The economy is in a recession and the recessionary gap is large. A discretionary fiscal stimulation package that would avoid a budget deficit is a simultaneous and equal increase in government expenditure and an increase in taxes. decrease in government expenditure and taxes. increase in transfer payments and a decrease in taxes, decrease in transfer payments and increase in the quantity of money increase in transfer payments and decrease in the quantity of money

Answer 1

To come out of recession the government needs to increase the aggregate demand. In case of large recessionary gap the first step taken by government to increase aggregate demand is to increase government expenditure. And since the government wants to avoid budget deficit it will have to increase it's revenue by same amount i.e increase the taxes by amount equal to the increase in government expenditure. Hence option(a) is correct and Option(b) is incorrect because there is a decrease in government expenditure.

Increase in transfer payment and decrease in tax will increase the disposable income and hence increase aggregate demand. But an increase in transfer payment will increase government expenditure and decrease in tax will decrease government revenue and thus there will be a budget deficit. So option (c ) increases aggregate demand but cannot avoid budget deficit. So option (c) is incorrect.

Change in quantity of money ( supply of money) is a monetary policy and not fiscal policy. Hence increase or decrease in quantity of money is not a fiscal stimulation package. So option (d) and option (e) are incorrect.

So correct answer is option(a).