For this question, assume that Ricardian Equivalence proposition does not hold. Briefly discuss the short-run, medium-run and long-run effects of a fiscal expansion (e.g. tax cut).

What will be an ideal response?


Answers could be quite long. In the short run, fiscal policy can affect the level of output, the composition of output, the price level, and financial market variables. In the medium run, changes in fiscal policy will not affect the level of output; however, they will affect the composition of GDP and financial market variables. So, a fiscal expansion would have no effect on output in the medium run. In the long run, fiscal policy will affect output. It will do so by affecting the level of national saving.