Question

Question 10 (1 point) If the government runs a deficit too big, the interest rate might increase. Investment is negatively related to the interest rate. However, Keynesian economists believe that I isn't very sensitive to the interest while Classical ones believe it is. Why does it explain (partially) why classical economists are more against the government spending money to stimulate the economy? (Note: difficult question as well] The less sensitive the investment is (to the interest rate), the more the AE curve would shift down in case of a deficit and the smaller the multiplier for G The more sensitive the investment is (to the interest rate), the less the AE curve would shift down in case of a deficit and the smaller the multiplier for G ( The more sensitive the investment is to the interest rate), the more the AE curve would shift down in case of a deficit and the bigger the multiplier for G The more sensitive the investment is (to the interest rate), the more the AE curve would shift down in case of a deficit and the smaller the multiplier for G of M

Answer 1

Last option is correct

If the investment is the highly sensitive to rate of interest, then government budget deficit will increase rate of interest which will reduce the investment by a large amount. This will shift the aggregate expenditure curve down more sharply and therefore the value of the government spending multiplier will be relatively smaller. this is because of a greater crowding out taking place when interest sensitivity is higher.