dyga

solarpower03 Wrote:
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> Hi all,
> Reading 23, Govt should increase budget deficit to
> stimulate economy. Can somebody explain why
> current govt (UK) is trying to reduce deficit.
> Obviously, I would request you to refrain from any
> political views but try to give a rationale for
> this.
> Many thanks


I had a big struggle with Reading 23. Later on I realised the Macroeconomics from L1 and Balance of Payment from L2 are essential to this reading. Anyway here is my attempt to your question:

The supply of loanable funds is = PS + (T-G) where PS is private savings defined as S + (M-X), T=tax revenue and G=govt spending.

An increase in (T-G) translate to a higher amount in loanable supply of funds for investments. Assuming no change in demand for loanable funds, the supply of loanable fund "shifts right" causing the real interest rate to decease.

[C.f.: Reverse of 'crowding-out' effect]

This in turn encourages less private saving and more spending. This in turns increase aggregate demand curve which results in an increase GDP.

Not sure whether I make sense....