If the government raised taxes and reduced government spending in ...

[lidoalex]

If the government raised taxes and reduced government spending in order to reduce the budget deficit, monetary policy could accommodate this policy by
 
  a. increasing money demand.
  b. increasing money supply.
  c. decreasing money supply.
  d. increase unemployment insurance.

Question 2

Why might the tax multiplier be smaller than the expenditure multiplier? Under what circumstances might the reverse be true?
 
  What will be an ideal response?

[tashiedavis420]

Answer to Question 1

B

Answer to Question 2

In the IS model, tax rate changes affect aggregate demand indirectly by influencing consumption. The size of the effect depends on the marginal propensity to consume, which is necessarily smaller than one. Government spending increases are directly and completely additions to aggregate demand. Reversal of the relative size of these multipliers is possible, because of further indirect and expectations-related effects. An expectation of future tax increases or an increase in the real interest rate reduces the size of both multipliers. If a tax cut is interpreted as a signal of an enduring commitment to lower taxes, then the tax multiplier might better resist this erosion and wind up larger in absolute value than the expenditure multiplier.