Monday, March 23, 2015

Government Spending & Taxes and Real Interest Rates

Government Spending and Real Interest Rates

If the Government is spending then the Real Interest rate is increasing.

FRQ's that ask about government spending always want to know the real interest rate. The loanable funds graph tell you whether the real interest rate is rising or falling.

Hint, if the government is spending the RIR is increasing.

Remember that Keynesian view spending is a short-term fix for a recession.
When the RIR increases, investment is reduced and growth is sacrificed and there will be less capital investment.

As for the decrease in taxes being expansionary. Take the view that with a balanced budget when the government reduces taxes it must make up the difference with Government spending.
The reasoning is a bit circular because the idea of a reduction in government is not entertained along with the reduction in taxes.

More about crowding out, soon.