-Suppose there is unemployment in the economy and the government attempts to
increase the level of national income by increasing government spending on public
goods (such as roads, dams) or on public services (such as education) that it receives
in tax collection.
-The government when faced with a budget deficit has two choices in financing it.
i) Print money through the central bank
ii) Borrow by selling bonds to the general public.
-If the government printed money and used it to purchase goods and services, then it
would be increasing the money supply, and this would be considered monetary policy
and not fiscal policy.
-An alternative to printing money is the open market operations by the central bank.
The central bank would buy bonds from the public in order to expand the money
supply.
-But crowding out results from the selling of new government bonds by the treasury to
finance the government deficit.
-The treasury in order to coax the public into buying government bonds rather than
bonds issued by private business lowers the price of government bonds, which would
concurrently increase the interest rate on those bonds.
-The impact of this higher interest rate on private saving and on net private investment
in the classical economy is illustrated in the figure below.
sharon kalunda answered the question on
April 11, 2019 at 11:41