Question

Econ 103: Bonus Problem Set

Due May 8th, 2018

Equivalent to 12% on a midterm, but does not affect the curve so

this is truly optional.

Trump has consistently pursued policies aimed at stimulating the economy. On

the regulatory side, his administration has worked to reduce regulation on corpo-

rations and banks. On the fiscal side, the president supported and signed the tax

cut act of 2017 reducing personal and corporate income taxes (among other things).

And on the monetary policy side, he has actively criticized the central bank’s ”tight”

monetary policy approach and called on the Federal reverse to reverse course, which

it did in 2019.

4. Next, let us turn to the long run effects of increasing the deficit.

a. Use the model of the market for loanable funds to explain what will

happen to investment.

b. How will this affect output in the future?

c. In the long run the government must run a balanced budget. What do

tax cuts today imply for future government services and taxes?

Answer 1

1. Loanable funds is the amount of money available for borrowing. The supply of loanable funds is based on savings and the demand for it based on borrowing. The interaction between the supply of savings and the demand for loans determines the real interest rate and how much is loaned out. Firms are the main borrowers of loanable funds, but they will only borrow if they can make an investment in real capital to produce a product or service that will have a higher return on investment than the interest rate being paid on loanable funds. In the present US scenario, when the tight monetary policies are relaxed, there is more loanable funds and hence investment that will bring in more revenue in terms of interest rates.
2. In the future, this will bring-in more investments and result in higher GDP and lower deficit though temporarily the deficit rates may increase as a result of increased spending and relaxed cuts
3. The financing of tax cuts significantly affects its impact on long-term growth. Tax cuts financed by immediate cuts in unproductive government spending could raise output, but tax cuts financed by reductions in government investment could reduce output. If they are not financed by spending cuts, tax cuts will lead to an increase in federal borrowing, which in turn, will reduce long-term growth. The historical evidence and simulation analyses suggest that tax cuts that are financed by debt for an extended period of time will have little positive impact on long-term growth and could reduce growth.