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Assume the economy is in a recession. The government has a high level of debt and...

Assume the economy is in a recession. The government has a high level of debt and wants to set a balanced budget, that is, G = T. You will be guided to show how the government can achieve a fiscal stimulus effect on GDP whilst keeping the budget balanced. To answer the question, assume that the economy is closed (there are no exports or imports) and the government collects lump-sum taxes. Now take the following steps:

(a) Show how this balanced-budget stimulus is possible in a multiplier diagram, ensuring that you label the relevant intercepts and angles. Make the diagram sufficiently accurate so that the exact size of the multiplier is visible.

(b) Explain in words how the government can achieve such a fiscal stimulus effect whilst keeping the budget balanced.

(c) Derive the balanced budget multiplier using algebra. (Hint: You will need to write down expressions for the change in GDP associated with a change in both G and T and set these equal to each other.)

(d) Comment briefly on any disadvantages you see with the use of this balanced budget fiscal stimulus.

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