Chapter 33 & 34 Crowding In, Crowding Out, Phillips Curve, Rational Expectations

Why do recessions add to national debt? When in a recession, we use expansionary fiscal policy – which means that G spending increases, taxes decrease, and transfers increase, thus adding to the national debt G T Tr

Crowding In & Crowding Out Crowding Out G spending increases AD, RGDP and PL, so D for Money increases, due to PL This increases i rates & MS The increase in i rates causes a decrease in I spending which lowers AD Crowding In Stimulation in G causes businesses to gain confidence and produce more to take advantage of the growing economy

Monetizing the Debt Because AD shifts right, the SCM shifts the AS curve to the left due to a rise in costs of production, which lowers profitability and AS The Fed can control i rates using Expansionary Monetary Policy to bring i rates down This will shift AD curve even farther out, increasing the national deficit The Fed is buying bonds that the gov’t is selling to fund their deficit ◦Fed creates money from government’s debt Monetizing the debt is more inflationary than non-monetized debt

Phillips Curve Inflation Unemployment Rate Long run Short Run Contractionary Policy Expansionary Policy Natural Rate of Unemployment SCM

Structural Deficit How the deficit would look if we were at full employment and the gov’t receives as much tax revenue as expected and spends only as much as expected

Costs of Closing Recessionary/Inflationary Gap Use Expansionary Fiscal Policy during a recession ◦Creates deficit – Increases G spending, decreases taxes, increases transfers Use Contractionary Fiscal Policy during an inflation ◦Decreases G spending, increases taxes, decreases transfers, which DECREASES THE DEFICIT and BALANCES THE BUDGET

Rational Expectations Forecasts that are the best that can be made given the available data, not necessarily correct If correct, short run PC is vertical ◦Inflation can be produced without the need for high unemployment Why Keynesians and Liberals want to fight unemployment: ◦Believe AD and SR PC curve is flat ◦Unemployment is more costly than inflation ◦Expectations react sluggishly, SCM is unreliable and slow

Rational Expectations Why Rational Expectation Adherent and Conservatives are more eager to fight inflation: -Because AD and SR PC is steep -Inflation more costly than UE -Depends on region of AS -Expectations react quickly -SCM works smoothly and rapidly