Suppose policy makers pass a budget that results in a reduction in the budget deficit. Also assume that this fiscal policy action results in an increase in the saving rate. To what extent will this increase in the saving rate cause permanent changes in the rate of growth of output per worker? Explain.

What will be an ideal response?

ANSWER:

A budget that causes a reduction in the budget deficit will cause an increase in the saving rate. Increases in the saving rate will only temporarily affect the growth rates of Y and Y/N. Once the new balanced growth equilibrium is achieved, the growth rates of Y and Y/N will return to their original levels.