The ARRA was an example of discretionary fiscal policy with an implementation gap due to delays in spending. The potential increase in GDP was calculated using the tax cut, spending, and transfers amounts, resulting in a total potential GDP impact of $7.6 trillion, and likely increased the national debt.
Understanding the ARRA and Its Impact on Fiscal Policy
The American Recovery and Reinvestment Act (ARRA) was a classic example of discretionary fiscal policy, designed to combat the Great Recession. Given that it involved deliberate changes to tax and spending levels through new legislation, it wasn't an automatic stabilizer like unemployment benefits that kick in without legislative changes.
An implementation gap is evident given that while the ARRA was signed in February 2009, the majority of spending took place in 2010 and 2011, indicating a delay between policy enactment and its practical application.
Given the marginal propensity to consume (MPC) of 0.9, the maximum increase in GDP from the tax cut can be calculated as the tax cut amount multiplied by the spending multiplier (1/(1 - MPC)):
Tax Cut GDP Impact: $280 billion * (1/(1 - 0.9)) = $280 billion * 10 = $2.8 trillion
Government Spending GDP Impact: $280 billion * 10 = $2.8 trillion
Government Transfers GDP Impact: $200 billion * 10 = $2 trillion
Total Maximum Change in Spending: $2.8 trillion (tax cut) + $2.8 trillion (spending) + $2 trillion (transfers) = $7.6 trillion
The national debt would likely have increased as a result of the ARRA, since it was funded by government borrowing.