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1. Currently there has been considerable debate in Canada about the fiscal deficit. Now lets assume that the government spending will be reduced in the future. Using the market clearing Real Business Cycle model framework, illustrate how the economy would respond today to an expected reduction in future government spending. Explain how output, employment wages, interest rates, and the price level respond.

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As expenditure falls prices will decline.In classical theory or Keynesian theory demand for labour falls, unemployment increases in short run. But in real business cycles, agents are rational. They can predict what will exactly happen . they know real wages will also fall. Hence employment and output will not fall. Wages will remain same but real wages will fall. Price level will fall. Interest rate will remain same

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