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What happens to aggregate consumption if the fiscal consolidation was undertaken by reducing G? And in...

What happens to aggregate consumption if the fiscal consolidation was undertaken by reducing G? And in the case it was realized by increasing T?

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Answer #1

In both cases, aggregate consumption will decrease.

When G decreases, aggregate demand directly decreases by more than the amount of fall in G due to spending multiplier effect. When T increases, aggregate demand decreases due to a decrease in disposable income, which lowers personal consumption expenditure, by more than the amount of rise in T due to tax multiplier effect. However, since spending multiplier is higher than the absolute value of tax multiplier, the decrease in aggregate consumption is higher for a decrease in G compared to the same amount of increase in T.

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