How would the U.S. government most likely respond to a slump in the economy using fiscal policy?

• A. Decrease government spending and raise taxes to reduce the budget deficit.
• B. Maintain current levels of government spending and taxation to avoid market intervention.
• C. Increase government spending and/or reduce taxes to stimulate aggregate demand.
• D. Implement contractionary monetary policy to control inflation.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the goal of fiscal policy during an economic slump. The government aims to stimulate economic activity and increase aggregate demand to counteract the downturn.
2. Step 2: Identify the two main tools of fiscal policy: government spending and taxation. Increasing government spending injects money directly into the economy, while reducing taxes increases consumers' disposable income.
3. Step 3: Recognize that increasing government spending and/or reducing taxes are expansionary fiscal policies designed to boost aggregate demand, leading to higher output and employment.
4. Step 4: Contrast this with contractionary fiscal policy, which involves decreasing government spending or increasing taxes, typically used to reduce inflation rather than address a slump.
5. Step 5: Conclude that in response to a slump, the U.S. government would most likely increase government spending and/or reduce taxes to stimulate aggregate demand and promote economic recovery.