Reference no: EM132476401

The Japanese economy has been hit by an outbreak of covid-19 virus and its GDP has shrunk. This has reduced the government's tax revenues at current tax rates. At the same time, the government urgently needs to spend a sizable sum (between $40 and $50 billion) to contain the virus outbreak. If the government does not contain the virus, the loss of output would be more than $100 billion. The government of Japan has a very large public debt (amounting to about 250 percent of GDP), but it has excellent credit rating in global financial markets and can borrow well over $100 billion without any notable change in the interest rate, which is practically equal to zero. The virus outbreak may cause some inflation, but that is not a concern in Japan because inflation is below its target. The government of Japan has been following an optimal fiscal policy in the past several years so that its current expenditures fund projects that are all valued more than their costs. In this situation, if the government wants to continue its optimal fiscal policy, which of the following would be a better option?

1) The government should spend the amount needed to contain the outbreak and finance it by cutting its current project expenditures, so that the public debt does not rise.

2) The government should refrain from spending more to contain the outbreak and make sure that the public debt does not rise any further.

3) The government should spend the amount needed to contain the outbreak and finance it by raising tax rates.

4) The government should spend the amount needed to contain the outbreak and finance it by borrowing more.