Macroeconomics
This represents the government’s accumulated defcits over the years and requires the government to pay the principal amount borrowed in addition to interest. This incurs an opportunity cost, as the funds used for repayment could have been allocated elsewhere. An increase in budget defcits adds to the national debt. 3. Balancedbudget wherebytaxrevenueisequaltogovernmentspending(T=G).Thisscenariois favorablewhentheeconomyisalreadyoperatingatitspotentialoutputlevel,meaningthatitis at the long-run equilibrium level where AD intersects with SRAS and LRAS. D. Crowding out As explained in the previous section, when a government runs a budget defcit (G > T) as part of an expansionary fscal policy, it may need to increase its borrowing to cover its expenditures. More spendingmayseemthewayoutofarecession.However,suchactionscanhavenegativeimpactsonthe economy by reducing private investment.Thisconceptisreferredtoascrowdingoutexplainedonthe graph below.
Here’s what causes crowding out: ➔ As governments increase their borrowing, they compete with other entities in the economy seeking to borrow from the fnite pool of savings or loanable funds. ➔ ThisisreflectedbyanincreaseinthedemandforloanablefundswhichshiftsitscurvefromD LF ₁ to D LF ₂. ➔ As a result, the real interest rate increases, e.g., from r.i.r₁ to r.i.r₂. ➔ Anincreaseintherealinterestratemakesitmorecostlyforprivatefrmstoborrow.Asprivate borrowing decreases, private investment drops (crowds out).
156
© 2024 ACHIEVE ULTIMATE CREDIT-BY-EXAM GUIDE|MACROECONOMICS
Made with FlippingBook - Online Brochure Maker