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Chapter 13: Q. 13.2 (page 281)

Discuss ways in which indirect crowding out and direct expenditure offsets can reduce the effectiveness of fiscal policy actions.

Short Answer

Expert verified

As shown in the figure, the I.S curve shifts from I.S to I.S2to the right. The economy should move to equilibrium E1at output Q2, but in the real economy it moves to E2at output Q3, so the decrease in output from Q2to Q3is generally due to crowding out. That is a concern for policy makers.

Step by step solution

01

Step 1- Introduction

The indirect crowding and diect expenditure offsets

Indirect crowding out -The crowding out effect is an economic theory that argues that increasing public sector spending reduces or eliminates private sector spending.

The crowding effect is a situation where rising interest rates reduce private investment spending, which weakens the initial increase in total investment spending.

Direct Expenditure- Direct expenses are payments to the department's account if no purchase order is required and the buyer's card is not accepted by the supplier.

Direct expenses are expenses related to the purchase of a product. Many companies are trading for resale and need to buy in bulk to work. Direct spending refers to everything related to what you buy.
02

Step 2- Explanation

E is the equilibrium of the I.S.-L.M. model. Therefore, if the government spies, fiscal expansion and a right shift in the I.S. curve will occur. However, the IS shift is not perfect. The highest government has increased by 1000, but I.S. The cost is less than$1000instead of $1000. Maybe it's $100or $200. In such cases, it is a problem because it causes crowding out of investment.

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Most popular questions from this chapter

2. Why do you suppose that some economists have argued that a key determinant of a nation's stabilization coefficient value is whether its government relies to a greater extent on automatic fiscal stabilizers instead of discretionary policy actions?

Recall that the Keynesian spending multiplier equals 1 /(1-M P C). Suppose that in Figure 13-4, the MPC is equal to 0.9. In addition, the amount of the horizontal leftward shift from AD2 to AD3 caused by a crowding-out effect on planned investment spending was 0.5\( trillion, or \) 500 billion. How much investment spending was crowded out?

A government is currently operating with an annual budget deficit of \(40 billion. The government has determined that every \)10 billion reduction in the amount it borrows each year would reduce the market interest rate by 0.1 percentage point. Furthermore, it has determined that every 0.1-percentage-point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to \(5 billion. The marginal propensity to consume is 0.75. Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to \)40 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes? (Hint: How much new private investment spending is induced by each $10 billion decrease in government spending? )

Determine whether each of the following is an example of an automatic fiscal stabilizer.

a. A federal agency must extend loans to businesses whenever an economic downturn begins.

b. As the economy heats up, the resulting increase in equilibrium real GDP per year immediately results in higher income tax payments, which dampen consumption spending somewhat.

c. As the economy starts to recover from a severe recession and more people go back to work, government-funded unemployment compensation payments begin to decline.

d. To stem an overheated economy, the president, using special powers granted by Congress, authorizes emergency impoundment of funds that Congress had previously authorized for spending on govemment programs.

1. Other things being equal, what features of a nation's economy do you think would tend to contribute to a higher value for its stabilization coefficient? [Hint: Consider the chapter's discussion of the reasons fiscal policy actions tend to have larger effects on real GDP.)
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