Fiscal Policy, Crowding out, Supply-side, Economics

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Economics Assignment #2 Question I. Fiscal Policy and the Crowding Out Effect. (a) What is the essence of the accounting identity (the so called saving investment identity) that the two distinguished professors refer to? Saving investment identity is a concept in National Income accounting that states that the amount saved (S) in an economy is equal to the amount invested (I). It is an equilibrium expressed in terms of supply (S), and demand (I), for lending (loan-able funds). Sp (Private Saving) + Sg or (T-G) (Government Saving or Budget Balance) = I. The authors are assuming full employment, where S=I. The saving “identity” where S=I holds true by…show more content…
Again, they are assuming the economy is at full employment or full potential when in fact, we are below full employment. Therefore the savings investment identity does not prove anything about the effectiveness of fiscal policy. Fiscal policy is a completely valid and effective method to expand the economy and move towards full employment. Fiscal policy can raise GDP, create jobs, increase income, etc… which is very beneficial. How can these professors be so ignorant of the full picture? They are not taking all the proper details into account it’s very surprising. Again, we are in a recession, this allows GDP to rise. An increase in G, increases GDP, which increases S. Therefore the actual degree at which interest rates rise and investments fall is not in line with what the professors think. They’re off. They have not accounted for the rise in GDP and have mistakenly assumed full employment and 100% crowding out effect when this is clearly not the case in a recession. An example from the text that illustrates the flaw in their argument: “In the case of [government] infrastructure spending, MPKf rises, so investment increases. Saving shifts and investment shifts. With upward shifts in both saving and investment, the new equilibrium is one with a
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