A decline in the structural deficit is generally a sign that fiscal policy: a. is working...

A decline in the structural deficit is generally a sign that fiscal policy:

	a.	is working to stimulate AD.
	b.	is working to restrain AD.
	c.	is having no effect on AD.
	d.	is turning into monetary policy.

Expert Solution

When government faces budget deficit due to higher government expenditure for increasing aggregate demand, then for financing these deficits, government borrow from loanable fund market. As a result, demand for loanable fund increases, so demand curve shifts rightward. Hence real interest rate increases. At higher interest rate private investment spending decrease. So the extra government expenditure done by the government diminishes for increasing aggregate demand. This is known as the crowding out.

Hence it means if government borrows from loanable fund market for financing its fiscal deficit, then private investment decreases and therefore there will be no effect of the expansionary fiscal policy. Therefore a decline in the structural deficit is generally a sign that fiscal policy is working to stimulate AD. This is because with the decrease in the structural deficit, the expansionary fiscal policy will be effective.

Hence option a is the correct answer.

Rahul Sunny answered 2 years ago

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