Question

Which combination of fiscal policy actions would most likely be offsetting? 
A. Increase taxes and government spending
B. Decrease taxes and increase government spending
C. Increase taxes, but make no change in government spending
D. Decrease taxes, but make no change in government spending

Answer 1

Answer: Option (A) is correct.

Explanation:

When there is an increase in both the components of aggregate demand i.e. government spending and taxes then this will most likely to offset the fiscal policy actions.

If there is an increase in the taxes, as a result aggregate demand decreases because of lower disposable income. This policy action is known as Contractionary fiscal policy.

Whereas, if there is an increase in the Government spending, as a result aggregate demand increases. This policy action is known as Expansionary fiscal policy.

But this will also largely depend upon the tax multiplier and government spending multiplier.