How to solve answer this for full points FRED 3060 2500 2007

FRED 3060 2.500 2007 20:2 2015 Figure 8: Solid Line, Left Scale : Output Gap, percent of Potential GDP Dashed Line, Right Scale: Real US Government Expenditures and Investment, in dollars 12. In the figure above, we see that the during the recession of 2008, the output gap (solid line) grew to almost 6% of GDP, and did not fall to under 1% of GDP until 2015, Explain whether fiscal policy (the dashed line) was counter-cyclical, or pro-cyclical, during the time period shown. Explain your answer, and justify whether or not you think the fiscal policy carried out was appropriate. 10 points

Solution

Output gap refers to the gap or difference between actual GDP and Potetial GDP . Here we can see that before 2008 there was positive output gap or actual GDP was greater than potential . This is the period of inflation or boom .

But since 2008 the scenario changed , the output gap became negative or there was recession . If a fiscal policy makes the business cycle condition worse by adding stimulus during a boom or adding more austerity during a recession then it is procyclical .

But if a policy moderates the cycle then it is countercyclical in nature . Here the fiscal policy was pro cyclical in nature . Due to this policy the recession slowly gained momentum and widened after 2008 . It could not moderate it . Hence it was not appropriate .