Monetary and Fiscal Policy Combinations: Stabilization Policy in the Real World.

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Presentation transcript:

Monetary and Fiscal Policy Combinations: Stabilization Policy in the Real World

Policy Lags and Crowding-Out Effect ► Effects of Government Budget Deficits:  Direct Effect: Increase in interest rates and crowding out ► Crowding out is the decrease in private demand for funds that occurs when the government’s demand for funds causes the interest rate to rise.  Indirect Effect: possibility of increase of private savings and decrease in consumption that offsets predicted expansionary effects of expansionary policy (Barro-Ricardo Effect)

Policy Lags ► Inside Lag: Time it takes for data to be collected, policy makers to recognize the policy is necessary, decision about which policy should be taken, and the implementation of the policy ► Outside Lag: Time it takes for the economy to respond to the new policy (differ in length for monetary and fiscal policies)

Government Demand for Funds Increases Demand for Money

Loanable Funds Market ► I and i are the initial equilibrium values. ► D = private sector demand for funds (Investment) ► D + (G–T) = private + government demand for funds ► I1 and i1 are the new equilibrium values. ► I2 = new level of private investment ► I1 – I2 = government demand for funds (G– T)

The Effects of Policy Changes in Multiple Markets