Question

1.Explain how a larger government budget deficit increase the magnitude of the crowding-out effect?

2. When an economy is already at full employment, what is the outcome of expansionary fiscal policies to employment, inflation, real output, and deficits (assuming no changes in tax rates)?

Note :- Please avoid Plagiarism( not copy paste from other post0

Answer 1

1. Large govt budget deficit mean governments have to borrow from the market. This leads to increase in interest rates as the demand for loans increases. This leads to private players/entrepreneurs not being able to avail loans at a cheaper rate. Which hampers their ability to invest and entrepreneurs depend on loans to make investments.

This pushing out of private entrepreneurs because of increase in government loans is called crowding out effect.

2. Expansionary fiscal policy is usually used when economy is in recession and below full employment level by increasing government spending or decreasing taxes to increase household consumption.

When government uses expansionary fiscal policy at full employment level. There cannot be any change in employment as economy is at full employment level already. There is an increase in inflation as shown in images. Real output decreases as income cannot increase but price increases and real output is Income/Prices. Deficit increases as government spending increase without any increase in taxes or income.