2. Decide whether an increase in government spending financed by a budget defici

Question

2. Decide whether an increase in government spending financed by a budget deficit (borrowing) would increase (+), decrease (), or have no effect (0) on each of the following economic variables under the view given in the question. a. the real interest rate under the crowding-out view b. the real interest rate under the new classical view c. private borrowing for investment under the crowding-out view d. personal saving under the new classical view e. foreign capital investment in the United States under the crowding-out view f. U.S. net exports under the crowding-out view g. aggregate demand under the Keynesian view h. aggregate demand under the crowding-out view -1, aggregate demand under the new classical view

Explanation / Answer

a) no effect, the increase in government spending will increase the real interest rate but the increase in the interest rate will crowd out the investment thus reducing the interest rate to its previous level.

b) In the classical view since there is no crowding out, the interest rate will rise.

c) private borrowing will decrease due to increase the interest rate.

d) personal saving will go up(incresae) due to increase in the interest rate.

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