The expansionary effects of an increase in government expenditures will tend to be offset, at least partially, if
A) government borrowing drives interest rates upward.
B) taxes are not also increased.
C) business decision makers and consumers become more optimistic as the result of the fiscal stimulus.
D) the economy is operating well below its full-employment capacity.

Question

Quizplus · Accepted Answer

An increase in government expenditures increases the demand for goods and services, which can lead to inflationary pressures. To offset this inflationary pressure, the central bank may increase interest rates. This increase in interest rates may discourage private sector spending and investment, partly offsetting the expansionary effects of the increase in government expenditures. Thus, choice A correctly explains the offsetting effect of an increase in government expenditures. Choice B is incorrect because, in the absence of a corresponding increase in taxation, an increase in government expenditures will tend to stimulate aggregate demand, and therefore, economic growth. Choice C is also incorrect because while increased optimism can stimulate consumption and investment, it may not be enough to offset the inflationary effects of an increase in government expenditures. Choice D is incorrect because an economy operating below full-employment capacity means there is room for growth, and any increase in government expenditures would tend to push the economy towards full employment.

The Expansionary Effects of an Increase in Government Expenditures Will