Question

. What are the “crowding-out effects” that limit the effectiveness of fiscal and monetary policy to stimulate the economy under the IS-LM mechanism? Specifically:

a. How would the interest elasticities of the demand for investment and money affect the efficacy of fiscal vs. monetary policies?

b. How would uncertainty about expected future taxes and regulations that increase labor costs to firms affect “autonomous” investments (the constant term in the investment demand function) and equilibrium output?

c. How do financial regulations on banks about bank capital adequacy and leverage, risk management, and reporting requirement affect equilibrium Q?

Answer 1

Fiscal deficit = {(revenue + grants) – (expenditure on goods and services + transfers) –
(lending – repayments)

The conventional budget deficit can be regarded as the resources needed during a
fiscal year after government income has been deducted from total expenditure. The latter
expenditure total includes interest payments but not any amortization of public debt.