Suppose fiscal policy makers pass a budget that increases taxes in the current period and are expected to raise taxes in the future. Use the IS-LM model to illustrate graphically and explain the effects of this policy on current output and the current interest rate

What will be an ideal response?

The increase in current T will cause disposable income to fall and current C to fall. This will cause the IS curve to shift left. The increase in future expected taxes will, all else fixed, decrease human wealth and current consumption. This will also cause the IS curve to shift left. As future T is raised, future Y will fall. This will depress both current C and I and, again, IS shifts to the left. The drop in future interest rates will have the opposite effect on C and I causing the IS curve to shift right. In theory, the effects on current output are ambiguous. The lower expected future interest rates have a positive effect on current demand. All other factors have the opposite effect.