Question

P2. In late December 2017, Congress passed, and President Trump signed, a massive overhaul of the tax laws that took effect in January. Last week, the Congressional Budget Office reported that America’s deficit is rising sharply and will surpass $1 trillion per year in just two years, a change they attributed to Congress cutting taxes and increasing spending, The CBO also said the federal deficit will hit $804 billion in fiscal 2018, up 21 percent from 2017. Use your models from class to describe what this deficit will mean for the U.S. economy (income, prices and unemployment) over the course of the next two years assuming the Fed seeks to maintain the current level of inflation. Also assume the U.S. economy is at full employment currently

Answer 1

Economy is already at full employment level. Which implies that rise in aggregate demand is not likely to push up real GDP of country.

Reduction in tax rate and increase in government spending will increase deficit of government over the next two years.

These measures would increase aggregate demand of economy. Rise in aggregate demand without commensurate rise in production of goods and services will lead to rise in price level only. Nominal income of people will also rise.

Hence:

Price level: Will rise.

Income level: WIll rise

Employment: Will Stay same.