Question

A government committed to long-run fiscal discipline (i.e. low and zero budget deficits) usually conducts contractionary fiscal policy at some point to reduce the government deficit. If that action is interpreted as a commitment to long-run fiscal discipline, a) describe the effects on autonomous consumption and investment expenditure. b) describe the effects on the cost of borrowing by issuing bonds.

Answer 1

a) Contractionary fiscal policy is followed by the federal government in order to reduce the inflationary pressure when the economy witness the rate of more produced goods and services. That is the rate of inflation crossing beyond the positive sign of economic level of development. In order to reduce the government deficit, by balancing the point of disastrous effect of inflation, government reduces the money supply and increases the interest rate in order to pay for the borrowed funds in the time of economic crisis when the housing bubble and abnormal price value of other assets took place in the economy which faces government deficit. So federal government follows the plan of contractionary policy in the long-run fiscal discipline with the parallel effects on autonomous consumption and investment expenditure by following ways. When the government imposes taxes heavily in order to curtail the inflationary pressure, the autonomous consumption pattern of basic needs like foods, shelter, day to day utility services, education and health care. As the service value rises for those expenses, it really affect the autonomous consumption when they have the less income in their hands to spend and secondly on the other side, the business people cannot able to invest in the new business ventures as the rate of interest for the parting money with the bank asset was goes to very high level. As the step of curbing the inflationary pressure, federal government may instructs the commercial banks to restrict the loan advances to the investors in the business circle. It is considered as the evil effects of contractionary policy on investment expenditure unless inflation controlled in the tight and heat economy.

b) In order to curb the evil effects of government deficit, federal government issues bonds and treasury bills in order to pool the funds by making it in to productive actions of nation building activities in all the states of the US nation. But the value of such bonds and treasury bonds shoots up to very high level beyond the market as well the stock value across the global financial stock markets. So investors will have very pain to buy such bonds and treasury bills. Government instructs consumers to save the monetary resources in the form of bonds and treasury bills. This is because of the attitude of federal government to decrease its money supply in order to short the liquidity of cash inflow among tight economy leading to high level of increase in the prices and assets worth.