Life has become yet more complicated. Government spending works with a distributed lag. Now when $1 billion is spent today, GDP increases by $1 billion this period and $1.5 billion next period.
a. What happens to the path of GDP if government spending rises enough this period to put GDP back to its potential level this period?
b. Suppose fiscal policy actions are taken to put GDP at its potential level this period. What fiscal policy will be needed to put GDP on target next period?
c. Explain why the government has to be so active in keeping GDP on target in this case.