Suppose the GDP is $40 billion below its potential level. It is expected that next-period GDP will be $20 billion below potential and that two periods from now it will be back at its potential level. You are told that the multiplier for government spending is 2 and that effects of the increased government spending are immediate. What policy actions can e taken to put GDP back on target each period? Solution Hi, The first step would be to change the monetary policy of the government. The low GDP is a sign on recession and in recession the supply of money in the economy decreases. The interest rate should be increased so as to promote investment and increase the money supply in the economy. The increased government spending is also one of the ways to increase the supply in the economy..

1. Suppose the GDP is $40 billion below its potential level. It is expected that next-period GDP will
be $20 billion below potential and that two periods from now it will be back at its potential level.
You are told that the multiplier for government spending is 2 and that effects of the increased
government spending are immediate. What policy actions can e taken to put GDP back on target
each period?
Solution
Hi,
The first step would be to change the monetary policy of the government. The low GDP is a sign
on recession and in recession the supply of money in the economy decreases. The interest rate
should be increased so as to promote investment and increase the money supply in the economy.
The increased government spending is also one of the ways to increase the supply in the
economy.