Question

You had four policy decisions to make on interest rates, income tax rates, corporate tax rates and government spending and were measured on four outcomes: GDP growth, unemployment rate, inflation rate, and budget surplus (or deficit). What is the theoretical or textbook link between each of the decisions and each of the outcomes? Positive? Negative? or Neutral?

[You may create a four by four grid that simply shows the connection, but you should explain the connections]

	GDP growth	Unemployment rate	Inflation rate	Budget surplus
Interest rates	Negative
Income tax rates
Corporate tax rates
Government spending

Answer 1

The table has been filled below. Explanation follows.

Higher interest rate means lower money supply. Lower money supply results in lower GDP growth as investment is less. Lower GDP growth leads to lower unemployment. lower money supply also leads to lower inflation as there is lesser money to go around. It has no impact on budget surplus (at least directly).

Both income tax and corporate tax work in the same way. The lower the tax, the higher is the money available for spending and investment and the higher is the GDP growth. The higher the GDP growth, the lower the unemployment. Higher investment and GDP growth also leads to higher inflation. Higher taxes means more revenue for the government and hence higher budget surplus and vice versa.

Government spending is directly proportional to GDP growth. The higher the government spending, higher the GDP and lower the unemployment rate. Higher GDP growth leads to higher inflation. Higher government spending means lower budget surplus, obviously.