Question

The new classical critique of activist fiscal policy is theoretically different from the crowding-out critique. Crowding-out occurs when private spending __________ in response to government spending. Under the new classical critique, increased government spending leads people to __________ their current savings in order to help pay for higher taxes in the future, which increases the __________ of loanable funds.

1) decreases; decrease; supply
2) increases; increase; demand
3) decreases; decrease; demand
4) decreases; increase; supply

Answer 1

The correct answer is 4) Decreases, increase, supply

Step-by-step explanation:

• Crowding out occurs when private spending decreases in response to government spending.

Goverment spending causes the interest rate to rise, and a higher interest rate means less private spending.

• Increased goverment spending leads people to increase their current savings.

Government has three sources of income: issuing debt, printing money, and collecting taxes. When the goverment increases spending, people expect taxes to increase as well, because it is usually the most important financial source for the goverment.

• Which increases the supply of loanable funds.

The more income is saved, the more of it can be saved. An economy without savings cannot invest because it would use all of its income to pay for expenses. If people begin to save more, for example, in the bank, the bank will have more deposits available to loan to firms, that will use those loans to invest.