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Question 36 (1) Using IS/LM curves diagram explain the likely effects of a fiscal expansion financed by government borro...


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Transcribed: Question 36 (i) Using IS/LM curves diagram explain the likely effects of a fiscal expansion financed by government borrowing on both the domestic interest rate and the level of economic activity. (ii) Explain what is the national debt and why keeping the national debt down as a percentage of GDP can be a good thing. (iii) Explain the term crowding out and why it is important when examining the effects of fiscal policy.

Answer

The IS LM model depicts both the goods and money markets in equilibrium at the same time. The IS curve depicts equilibrium in the goods market at each and every point. In money market equilibrium, the LM curve functions similarly. Expansionary fiscal policy is when the government uses budgetary instruments to expand the money supply in the economy by either increasing spending or cutting taxes, resulting in more money available to invest for customers and businesses. Expansionary fiscal policy aims to promote economic growth to a healthy level, which is necessary during the business cycle's contractionary phase. The government is attempting to cut unemployment, increase consumer demand, and bring the recession to an end. 

 

Economics homework question answer, step 2, image 1

Fiscal expansion will cause the IS curve to shift to the right. The expansion  is funded by borrowing, which will result in a lack of cash in the banks, raising the interest rate. As a result, rising interest rates as a result of borrowing will discourage private investment. IS curve shifts outwards to IS1 when government expenditure grows. This is because aggregate demand has grown at the current level of income. If the interest rate stays the same, the income level should be (y2), but this is not the case since government borrowing is possible when the government offers higher interest rates. As a result, the amount of cash available for private investment decreases. Higher interest rates discourage private investment, and the economy advances to a point where interest rates are (i1) and income levels are (y1).

The national debt is composed up of public and intra-governmental debt owing by the central government to the country's citizens and other governmental institutions. When the government spends more than it receives in tax income, it adds to the national debt. The debt is increased each year by the budget deficit. An rise in debt that is favorable would improve economic growth. However, even this growth in debt is dangerous if it occurs at a quicker rate, as it may result in an economic boom.

The debt-to-GDP ratio compares the magnitude of the government's debt to the economy's size. To put it another way, it demonstrates what productive activities support the government's debt. Problems develop when the government borrows more than the economy can generate. The debt-to-GDP ratio measures a country's public debt in relation to its gross domestic output (GDP). The debt-to-GDP ratio is a reliable indicator of a country's capacity to repay its debts since ...

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