Answer to Question #212314 in Macroeconomics for Akhona Klanisi

Question

Earlier in 2021, the minister of Finance Tito Mboweni presented the budget. Some economists speculated that since government is on the fiscal consolidation path. Government was going to raise taxes to reduce the budget deficit. However, on the contrary, government proposed reduced spending in form of slashed public wage bill. Use the AD-AS framework to explain logically the potential effect of such a policy move on output and prices. [Make reference to what happens to the curves but NO drawings of graphs required].

1. In the medium term

Answer 1

Reduced government spending will lead to a decreased aggregate demand thereby shifting the AD curve to the left. This is because the policy will lead to high interest rates, increasing prices of exports hence reducing the output.