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Crowding Effect: An evaluation to the use of Expansionary Fiscal Policy

For H2s:

• Government spending if financed by from D1 to D2 � upward pressure on i/rborrowing � cost of borrowing > expected yielf of the investment project investment projects are profitable

• Individuals may also be discouraged from borrowing

opportunity costs of savings increase falls � Fall in I and C� might offset effectiveness of expansionary FP AD3 instead of AD2.

Key Assumption: Increase in Gov expenditure from the same source of private lending institution reserves/savings from previous budget

Crowding Effect: An evaluation to the use of Expansionary Fiscal Policy

Government spending if financed by borrowing � competition for loans upward pressure on i/r � increase i/r from R1 to R2 �

cost of borrowing > expected yielf of the investment project investment projects are profitable ��volume of investments falls from Q1 to Q2

scouraged from borrowing � returns to savings are higher opportunity costs of savings increase � consumption expenditure on goods bought on credit

might offset �G � AD falls from AD2 to AD3 effectiveness of expansionary FP � Hence total net effect of Increase G = AD1 increase to

Key Assumption: Increase in Gov expenditure ���� needs to be financed by borrowingfrom the same source of private lending institution ���� and/or government has no past

revious budget year surpluses.

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�� dd for loans raises the cost of

cost of borrowing > expected yielf of the investment project � fewer from Q1 to Q2

returns to savings are higher � consumption expenditure on goods bought on credit

AD falls from AD2 to AD3 � limits the l net effect of Increase G = AD1 increase to

borrowing and/or government has no past

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