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Chapter 27: Problem 7

Suppose that at the same time that Congress and the president pursue an expansionary fiscal policy, the Federal Reserve pursues an expansionary monetary policy. How might an expansionary monetary policy affect the extent of crowding out in the short run?

Short Answer

Expert verified
In the short run, expansionary monetary policy, which involves increasing the supply of money and lowering interest rates, can reduce the extent of the crowding out effect caused by an expansionary fiscal policy. This is because lower interest rates may stimulate private investment. However, these effects are specific to the short run, long-term impacts might be different.

Step by step solution

01

Understand Expansionary Fiscal and Monetary Policies

Expansionary fiscal policy involves the government attempting to expand the economy by increasing spending or reducing taxes, which can increase the deficit and result in government borrowing. On the other hand, expansionary monetary policy refers to the actions taken by a central bank like the Federal Reserve to increase the money supply and lower interest rates in an attempt to stimulate economic growth.
02

Discuss Crowding Out Effect

The crowding out effect occurs when government borrowing leads to higher interest rates, discouraging private investment. This is often a consequence of an expansionary fiscal policy where government increases spending or reduces taxes, thus increasing deficit and borrowing.
03

Consider Expansionary Monetary Policy Effects

The expansionary monetary policy, by increasing money supply and lowering interest rates, can counteract the crowding out effect. Lower interest rates can encourage private investment.
04

Conclude

In the short run, an expansionary monetary policy may reduce the extent of crowding out. By increasing the supply of money and decreasing interest rates, the monetary policy can counterbalance the increased government borrowing and help to maintain or even stimulate private investment. However, it's pivotal to remember that this is a short run effect and long-term effects could be different.

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Most popular questions from this chapter

(Related to the Apply the Concept on page 978 ) In 2017 , an article in the New York Times quoted Douglas HoltzEakin, former director of the Congressional Budget Office, as arguing that "with the economy back to near full employment, conventional tax cuts or stimulus spending won't have that much of an effect. What is needed are policies that genuinely augment the supply side of the economy." a. If the economy is at full employment, what economic variables will conventional tax cuts or stimulus spending not affect much? What variables might these policies affect? b. What does Holtz-Eakin mean by "policies that genuinely augment the supply side of the economy"?

Why do few economists believe it would be a good idea to balance the federal budget every year?

What is meant by "crowding out"? Explain the difference between crowding out in the short run and in the long run.

In \(2017,\) an article in the Wall Street Journal discussed a report by the World Bank. According to the report, "More than half of emerging economies saw their debt-to-GDP ratios rise 10 percentage points and in a third, budget balances worsened by more than five percentage points." a. What does the report mean by "budget balances"? b. Is there a connection between these countries experiencing worsening budget balances while also experiencing increasing debt-to-GDP ratios? Briefly explain.

Briefly explain how an expansionary fiscal policy will cause each of the following variables to increase or decrease. a. Real GDP b. The unemployment rate c. The price level
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