Chapter 8: Fiscal and monetary policy in the Keynesian model

Question 1

What does fiscal policy use to impact equilibrium?

Answer 1

G and T

Question 2

What is the multiplier when analysing fiscal policy?

Answer 2

Ratio of change in Y to change in G is equal to the multiplier

Question 3

What happens when the tax rate is altered?

Answer 3

Effect:

• Autonomous expenditure remains the same
• Aggregate spending lower at every income level
• Excess supply resulting in increased inventories
• Lower production, lower income, lower induced consumption, etc
• Until at Eq

Increase of tax is contractionary and decrease is expansionary

Expansionary:
- Increase in G - income is a multiple of change in spending
- Decrease in T - tax increases multiplier
Contractionary
- Decrease in G - income is multiple of change in spending
- Increase in T - tax decreases multiplier

Question 4

Interest / monetary policy effect?

Answer 4

Impact on investment decision:

• Capital goods financing depends on the interest rate
• Growth on financial investment and opportunity cost of purchasing goods instead of investing

Low interest = higher investment

Increase in interest = contractionary
Decrease in interest = expansionary