Question

expansionary fiscal policy that creates a budget deficit can lead to crowding out. this crowding out effect is exhibited by part 2 a. increased government expenditures and decreased interest rates. b. increased taxes and increased investment. c. decreased government expenditures and decreased investment. d. increased government expenditures and decreased investment. part 3 increased government spending crowds out investment due to part 4 a. the existence of interest rate floors. b. stricter government regulations. c. an increased money supply.

Answer 1

Expansionary fiscal policy can lead to higher interest rates, which may discourage borrowing, resulting in the crowding out of private investment. This effect reduces the effectiveness of fiscal policy in stimulating aggregate demand. Nevertheless, expansionary monetary policy by the central bank may offset this effect when the economy is below its potential GDP.

Step-by-step explanation:

When the government engages in expansionary fiscal policy, such as increasing spending or cutting taxes, it aims to boost aggregate demand. However, this action can lead to a budget deficit and cause higher interest rates. The increased demand for financing the deficit puts upward pressure on interest rates, and consequently, firms and households may be discouraged from borrowing. This is known as the crowding out effect, where private investment is reduced due to higher costs of borrowing.

Crowding out can diminish the intended stimulatory impact of fiscal policy. The government's increased spending competes with the private sector for financial resources, leading to decreased investment from businesses and less consumption from households. However, if the economy is operating below its potential GDP, and the central bank implements expansionary monetary policy, these actions might counteract the higher interest rates caused by government borrowing, thus reducing the crowding out effect.