A government is currently operating with an annual budget deficit of $40 billion. The government has determined that: Every $10 billion reduction in the amount of bonds it issues each year would reduce the market interest rate by 0.1 percentage point. Every 0.1 percentage point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to $5 billion. The marginal propensity to consume is 0.75. To eliminate an inflationary gap and take into account the resulting change in the price level, the government must generate a net leftward shift in the aggregate demand curve equal to $40 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes?
Second Problem: Congress enacts a lump sum tax cut of $750 billion. The marginal propensity to consume is 0.75. Assuming that Richardian equivalence holds true, what is the effect on equilbrium real GDP? On savings?