lecture - crowding out

Crowding Out - A criticism of expansionary fiscal policy

n/a

According to the 'crowding out' theory, expansionary fiscal policy is:

1. Counter-productive

2. Causes slower future economic growth

n/a

Criticism 1: Expansionary fiscal policy is counterproductive.

A. Expansionary fiscal policy involves increasing government spending and / or lowering taxes

B. This increases the _______ curve by increasing G (government spending) and / or C (consumption).

ad

But the government can only raise spending and cut taxes by going into a budget DEFICIT / SURPLUS; that is, by borrowing.

n/a

If the government borrows money, it shifts the demand curve for loanable funds to the LEFT / RIGHT

right

This RAISES / LOWERS interest rates which causes Ig (investment) to decrease

1. This decrease in Ig from expansionary fiscal policy is called 'Crowding out'

2. We say that the government is 'crowding out' investment.

raises

The political cartoon version of this would be a bunch of business people showing up at a bank to try to borrow money to invest, but the bank is so full of people from the government borrowing to do expansionary fiscal policy that they can't even get in the door. The business people are being 'crowded out.'

n/a

So expansionary fiscal policy is counterproductive because it increases G or C but decreases ________.

Ig

Criticism 2: Expansionary fiscal policy causes slower future economic growth.

A. Faster economic growth comes from producing more CONSUMER GOODS / CAPITAL GOODS (remember the PPC and indicating faster or slower future economic growth).

capital goods

Since Ig is the production of capital goods, when expansionary fiscal policy raises interest rates and decreases Ig, it decreases capital production, causing slower future economic growth.

n/a

Preventing Crowding out.

The only way to prevent crowding out is to prevent interest rates from rising when the government borrows the loanable funds so that Ig does not decrease.

Of course, the part of the government that can control interest rates is the _________________, and it can prevent them from rising with _______________________________ monetary policy.

a. fed

b. expansionary

This is another reason why monetary and fiscal policy must be consistent with each other.

1. If one is expansionary and the other contractionary, they will largely….

2. If the fed does not do expansionary monetary policy when the congress does expansionary fiscal policy, interest rates will rise, and Ig will decrease.

3. Only the ___________________ can prevent 'crowding out.

a. cancel each other out

b. fed