Counteracting Expansionary Trade Surplus at Full Employment

Steps:

• A trade surplus increases net exports, shifting AD rightward and risking inflation at full employment.
• To maintain equilibrium, apply contractionary fiscal policy to offset the AD increase.
• Higher direct taxation with unchanged spending reduces disposable income and consumption.
• This creates a budget surplus, stabilizing output and prices without overheating.

Why B is correct:

• Budget surplus withdraws money from circulation (G - T < 0), reducing aggregate demand per Keynesian fiscal policy to neutralize the surplus's expansionary effect.

Why the others are wrong:

• A: Balanced budget multiplier is zero, so AD remains unchanged and fails to offset the surplus.
• C: Lower interest rates boost investment, expanding AD further and exacerbating inflation.
• D: Higher interest rates curb investment but represent monetary policy, not directly addressing the fiscal imbalance from the surplus.

Final answer: B