Question

1,Assume that the United States begins deficit spending to fund new social welfare programs.

Using a correctly labeled loanable funds graph, show and explain the impact of the new spending on real interest rates in the United States.

Explain the impact of the change in interest rates you identified in part (A) on each of the following:

a.Capital investment

b.Long-term economic growth

c.The international value of the U.S. dollar

2.

Assume a visitor from another nation decides to open a checking account at J & R National Bank. The visitor deposits $20,000 that is new money to the Macro Islands economy. The central bank has set a required reserve ratio of 10%.

i.What is the change in the total amount that J & R National Bank can loan out? Explain.

ii.Calculate the total amount that the bank can create? (Calculate means show your work.)

Now assume that the Macro Islands government decides to increase spending to fund new projects that will bring in more visitors. Explain what will happen to the demand for loanable funds and real interest rates as a result.

3.

If a decrease in personal income taxes increase aggregate income, then real interest rates will

A. decrease with a decrease in aggregate income.

B.increase with an increase in aggregate income.

C.remain stable as the decrease in taxes offsets the increase in aggregate income.

D.decrease with a decrease in aggregate income.

E.remain stable as the decrease in taxes offsets the decrease in aggregate income.

4.

Crowding out occurs when

A.the government is using contractionary fiscal policy. (my answer, correct?)

B.the government is using expansionary fiscal policy.

C.Congress increases personal income taxes.

D.Congress increases business taxes.

E.Congress increases spending and personal income taxes by the same amount.

Answer 1

Solution:

1.Impact of new spending on the real interest rates in the U.S : As the government is increasing its spending o new social welfare programs through deficit financing,implies that it is more and more money to finance the plan,so the interest rate increases.

From the graph,you can observe that as the demand for new loans increase (indicated by shift in the demand curve from D' to D''),the price (in this case the interest rates is increasing from Po to P1) as the supply remains the same (shown by curve SS')

Due to this :

a.Capital Investment :Capital investment will decrease as the interest rates will increase, making it difficult for the businesses to borrow.

b.Long-term economic growth : It is good for long-term economic growth.Expansionary fiscal policy is generally used to stimulate the economy by increasing the aggregate demand which ultimately leads to increase in the GDP of the economy.

c.The international value of U.S Dollar :Theinternational value of the U.S Dollar increases i.e., the U.S dollar strengthens relatively to other currencies.

2.Given that the required reserve ratio is 10% meaning a bank will have to maintain 10% of its deposits in the form of cash,so the remaining amount it can give loans.

(i) So 10% of $20,000 is $2,000.The bank can laon out an additional $18,000 (i.e., $20,000 - $2,000)

(ii)The demand for loanable funds will increase and so the real interest rates will increase as a result of this.

3.If a decrease in personal income taxes increase aggregate income, then real interest rates will :

B.increase with an increase in aggregate income.

4.Crowding out occurs when :

B.The government is using expansionary fiscal policy i.e., the government is increasing it's spending which is in-turn affecting the remaining market either on the supply or the demand side.

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