How much should the government increase taxes

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Reference no: EM13159660

A government is currently operating with an annual budget deficit of $40 billion. The government has determined that every $1- billion reduction in the amount it borrows each year would reduce the market interest rate by 0.1 percentage point. Furthermore, it has determined that every 0.1-percentage-point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to $5 billion. The marginal propensity to consume is 0.75. Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to $40 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes?

Reference no: EM13159660

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