Fiscal POlicy policy

PieMan

Why does expansionary fiscal policy lead to increased IR? Is it just due to crowding out?

huangxiaoxie

Expansionary fiscal policy leads to increased borrowing which leads to increased real IR.

There is a another debate on if the money is spent without raising taxes, but that is the simple answer if you see it.

flyinggirl

Here is a longer explanation using AS-AD and IS-LM models. G goes up -> IS shifts right and AD shifts right -> Prices go up -> LM shifts left
Since AD shift right and IS shifts right and LM shifts left -> output goes up, prices go up and interest rate goes up (some crowding out happens in the short run).

In the long run Prices go up even more as AS shifts left, output goes back to initial level but at higher price. LM shifts left even more, there is move along IS and interest rates go up even more. G completely overcrowds investments.