Anne and Charlie are discussing the best possible fiscal policy to bring the country out of a recession. Charlie wants to see government reduce taxes by $100 billion. Anne prefers to see government spending increase by $100 billion. Whose proposition would have the larger total impact on aggregate demand?

Question

Quizplus · Accepted Answer

Anne's proposition to increase government spending by $100 billion would have a larger impact on aggregate demand than Charlie's proposition to reduce taxes by $100 billion. This is because all of the additional government spending would enter the spending stream, while part of a tax cut would be saved and not spent. Firms and households do have a higher marginal propensity to consume than the government, but in this case, the difference in impact on aggregate demand is larger due to the spending not being diverted towards saving. Additionally, Anne's proposition is not necessarily better because the government has more information available to it than households and firms, as both approaches have their own advantages and disadvantages.

Anne and Charlie Are Discussing the Best Possible Fiscal Policy