Question

The recessionary gap in a country is $1 trillion. The spending multiplier is 5. For every $50 billion borrowed, interest rates increase by 0.1 %. For every 0.1% increase in interest rates, investment spending drops by $10 billion. How much should the government spend to bring the economy back to full employment? (Hint: the government must account for the crowding out effect. The fall in investment spending is also subject to the multiplier effect. For example, if investment falls by $10 billion, real GDP will fall by 5 x $10 billion = $50 billion.)