CFA Level I · CFA Level I Exam · Fiscal Policy
An economy is in a deep recession with high unemployment. Policymakers want a fiscal stimulus with the fastest and largest effect on aggregate demand per unit of budget cost. Which of the following is most likely to have the largest spending multiplier?
Direct government spending on infrastructure most likely has the largest multiplier, because the whole amount is spent in the first round. Tax cuts leak into saving, especially those going to high-income households or corporations, who have a lower marginal propensity to consume, so they stimulate demand less per unit of cost.
- AA broad cut in corporate income tax rates
- BDirect government spending on infrastructure projectsCorrect
- CA tax cut targeted at high-income households
Explanation
Direct government spending enters aggregate demand in full in the first round. Tax cuts are partly saved, and high-income households and corporations save a larger share than low-income households. Their multipliers are therefore smaller.
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