Question

If an economy is in a recession and the government opts for an expansionary fiscal policy to shift AD closer to potential output, an economist with a typical functional finance view who acknowledges partial crowding out would conclude that the AD:

A. shifts to the right due to higher government spending.
B. shifts to the left due to higher government spending.
C. does not shift since the higher government spending is offset by higher private consumption.
D. does not shift since the higher government spending is offset by lower private consumption.

Answer 1

According to the functional finance view in Keynesian macroeconomics, an economist would conclude that the aggregate demand (AD) curve shifts to the right due to higher government spending during a recession.

Step-by-step explanation:

According to the functional finance view in Keynesian macroeconomics, when an economy is in a recession, an expansionary fiscal policy is used to shift the aggregate demand (AD) curve closer to potential output. With this view, an economist would conclude that the AD curve shifts to the right due to higher government spending.

An increase in government spending would lead to higher AD because government spending is one component of AD. When the economy is below potential output, higher government spending would help stimulate the economy and pull it out of a recession. Although there may be some crowding out effect where higher government spending leads to higher interest rates and partially offsets private investment, the overall impact is still an increase in AD.