Recessionary Gap, Inflationary Gap, and the Fiscal Response

The idea

The exam describes an economy's position against potential GDP and asks the Keynesian prescription, and the anchor's two gaps decide it. A recessionary gap is equilibrium at output below potential GDP: unemployment above the natural rate, idle capacity. The response is expansionary fiscal policy, tax cuts to stimulate consumption and investment or direct increases in government spending, shifting aggregate demand right. An inflationary gap is equilibrium above potential GDP: unemployment low, the price level rising. The response is contractionary fiscal policy, tax increases or spending cuts, shifting aggregate demand left. The prescription is intervention at the macro level, raising demand when private demand falls and lowering it when private demand rises; it does not mean government setting prices and quantities in individual markets.