According to new classical economists, is financing a reduction in current taxes by government borrowing likely to result in an increase in: aggregate demand? the real interest rate? A. No No B. No Yes C. Yes No D. Yes Yes Please provide answer with explanation
well in theory the govt borrowing/spending is supposed to compensate for lower consumer/business demand so think would result in increased agg demand while keeping rates, albeit artificially, so will take stab with C, YES/NO. interested to learn outcome on this one…
My first thought is: On Aggregate Demand: No. The lower tax rate would influence SRAS not AD. On Interest Rates: Yes Supply and Demand for Loanable funds Model: Increase in demand for loanable funds = increase in real interest rates.
I think it’s B (NO, Yes) Assume Everything else the same (mainly money supply). Government borrowing will reduce money supply in the market. Thus, increase real interest rate. Increase Tax percentage would reduce aggregate demand, but this question not sure about tax percentage. only said reduce in tax, maybe economic slow down (like now). So demand should unchange. jgrandits said government spending will help increase demand. It’s true, but this question didn’t say government will spend it.
I would go for B as well, because for me it seems like crowding out effect, as increase in govt borrowing, most likely to results in increase in real interest rate. Since there is an increase in interest rate, aggregate demand will decrease. Moreover, question didn’t specify whether the govt will increase spending. As such, there is a least chance for AD to increase.