Fiscal Policy Multiplier

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3. Crowding out reduces the degree to which a change in government purchases influences the level of economic activity. Is it a form of automatic stabilizer? Crowding out is not a form of automatic stabilizer. Crowding out is “the tendency for expansionary fiscal policy to reduce other components of aggregate demand.” (Rittenberg and Tregarthen, 2012) This means that if the government increased purchases, the impact on change in policy is reduced because there would be an increase in the deficit and borrowing by selling bonds. This leads to the supply of bonds to increase and interest rates to rise. Then investments will decline, the exchange rates rise and exports decline (Rittenberg and Tregarthen, 2012). This is different from automatic stabilizers, which are “any government program that tends to reduce fluctuations in GDP automatically.” (Rittenberg and Tregarthen, 2012) While crowding out sounds like an automatic stabilizer, automatic stabilizers do not shift the aggregate demand curve because they are automatic and their actions are part of the curve already (Rittenberg and Tregarthen, 2012). The effects that lead to crowding out can be graphed as shifts in other components of aggregate demand. …show more content…

Why is it important to try to determine the size of the fiscal policy multiplier? The multiplier needs to be determined in order to properly calculate how much the aggregate demand curve shifts. Since the curve shifts “by an amount equal to the initial change in government purchases times the multiplier.” (Rittenberg and Tregarthen, 2012) Without knowing the size of the multiplier, it would be hard to determine how much the aggregate demand curve

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