EFFECTIVENESS OF
POLICY OPTIONS TO MEET
ALL MACROECONOMIC OBJECTIVES
CHAPTER 47
Unit 10 Government macroeconomic intervention
ZHAO Ke (Kevin)
Economic Instructor
OBJECTIVES (AL)
Students will be able to:
1. evaluate the effectiveness of fiscal policy including Laffer curve analysis in relation to
different macroeconomic objectives
2. evaluate the effectiveness of monetary policy in relation to different macroeconomic
objectives
3. evaluate the effectiveness of supply-side policy in relation to different
macroeconomic objectives
4. evaluate the effectiveness of exchange rate policy in relation to different
macroeconomic objectives
5. evaluate the effectiveness of international trade policy in relation to different
macroeconomic objectives
6. analyse problems and conflicts arising from the outcome of the different policies
7. explain the existence of government failure in macroeconomic policies.
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CONTENT (AL)
47.1 The effectiveness of fiscal policy in relation to different
macroeconomic objectives
• Crowding out and crowding in
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CROWDING OUT
There is a debate among economists as to whether higher government
spending always results in higher aggregate demand.
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CROWDING OUT
New classical economists argue that higher government spending, financed
by increased borrowing, would
1. reduces funds available to lend to the private sector
2. drives up the rate of interest
As a result, consumption and private sector investment may fall.
So increased public sector spending can crowd out private sector spending.
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CROWDING IN
Keynesians argued that higher government spending will raise GDP by a
multiple amount (multiplier effect).
The higher income will
• increase saving, which will provide the funds available to lend.
• encourage a rise in consumption and investment.
So higher public sector spending can stimulate private sector investment.
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CROWDING IN VS CROWDING OUT
Crowding in (Keynesian economics)
This effect is likely to occur in a deep recession when resources are idle. With
abundunt idle resources, the government spending puts unused resources back
to work, increasing overall income and creating new profitable opportunities for
the private sector. The "animal spirits" of the economy are revived.
Crowding out (the classical and neoclassical view)
This effect is likely to occur in a healthy, near-full-employment economy. With
few idle resources, the government must compete with the private sector for
capital (money) and physical resources. This competition drives up the price of
capital (the interest rate).
GIFTED (AS)
1. Monetarists believe that stimulative fiscal policy is ineffective because:
A price and wages do not change in the short-run.
B it causes the dollar to depreciate.
C it leads to crowding out of private investment.
D banks often build up reserves instead of lending them out.
E there is no multiplier effect.
GIFTED (AP)
2. Crowding out is most likely to occur with which of the following changes?
A Decrease in government spending
B Increase in budget surplus
C Increase in budget deficit
D Decrease in the real interest rate
E Decrease in trade deficit
GIFTED (NEC AS)
3. Which of the following is not true for the crowding-out effect?
A Federal budget deficits increase interest rates, which reduces investment
spending
B Crowding out reduces the ability of fiscal policy to combat a recession.
C If the government spends more on education, ceteris paribus, households
may be forced to spend less on new homes.
D Crowding out occurs especially when the economy is in a deep recession
and people are not spending all the available money.