Determining the new balanced budget rule

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Assume the economy is under full employment (long run) equilibrium. However, suppose households are uncertain about what events and policies may lie ahead, and decide to cut back consumption spending in order to increase saving for the future.

Now suppose the government has adopted a strict balanced budget policy that mandates that G=T each year. When people cut back their 2 consumptions (and before the economy recovers in long run), what impact would this new balanced budget rule have on the short run economic performance, i.e. output (Y), and price level (P)? Use AS-AD framework.

Reference no: EM132506850

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