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Question
Statistics
Posted 10 months ago

The government of Hamsterville has engaged in expansionary fiscal polic and the central bank has engaged in expansionary monetary policy. Assume that there is not complete crowding out.

What will be the effect of these policies on real gross domestic product (GDP) and interest rates in Hamsterville?

Choose 1 answer:
(A) Real GDP will increase; interest rates will decrease.
(B) Real GDP will increase; impact on interest rates will be indeterminate.
(C) Real GDP will increase; interest rates will increase.
(D) Effect on real GDP will be indeterminate; effect on interest rates will be indeterminate.
(E) Real GDP will decrease; interest rates will increase.
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Answer from Sia
Posted 10 months ago
Solution by Steps
step 1
Understand the effects of expansionary fiscal policy: Expansionary fiscal policy, which involves increased government spending and/or tax cuts, is designed to stimulate economic growth. Assuming no complete crowding out, this policy should increase aggregate demand, leading to an increase in real GDP
step 2
Understand the effects of expansionary monetary policy: Expansionary monetary policy, typically implemented by a central bank, involves lowering interest rates to encourage borrowing and investment. This policy should also increase aggregate demand, contributing to an increase in real GDP. Additionally, the immediate effect of this policy is to lower interest rates
step 3
Combine the effects of both policies: When both expansionary fiscal and monetary policies are implemented, the combined effect should be a more pronounced increase in real GDP. The fiscal policy may put upward pressure on interest rates by increasing demand for loanable funds, but the monetary policy aims to lower interest rates. Given that there is not complete crowding out, the monetary policy's effect on interest rates is likely to dominate, leading to lower interest rates overall
Answer
A
Key Concept
Combined effect of expansionary fiscal and monetary policies
Explanation
Expansionary fiscal policy increases real GDP by boosting aggregate demand, while expansionary monetary policy lowers interest rates to stimulate borrowing and investment. When both policies are in place and there is not complete crowding out, real GDP is expected to increase, and interest rates are expected to decrease.

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