Question: Suppose during some war in the future, military expenditures increased by 3% of GDP. Describe optimal Fed policy under the following scenarios. (Hint: what happens to consumer and capital spending after the war starts?)
(A) The government pays for the war with a tax increase.
(B) The deficit rises by the full amount of the increase in defense spending.
(C) Expectations decline, so the cutbacks in capital spending offset the rise in defense spending.
(D) The war causes oil prices to double.