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Chapter 26 Saving, Investment and The Financial System - Some Logics

The document outlines the crowding-out effect that can occur from increases in government spending or decreases in taxes. When government spending increases, the budget deficit rises, reducing the supply of loanable funds and increasing interest rates. This can crowd out private investment and lower economic growth. Similarly, a tax cut may increase consumption but reduce the supply of savings, again lowering the availability of loanable funds and crowding out investment. The author proposes an alternative simplified approach to demonstrate how a tax decrease could reduce total savings in the economy.

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Minh Châu Tạ Thị
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102 views

Chapter 26 Saving, Investment and The Financial System - Some Logics

The document outlines the crowding-out effect that can occur from increases in government spending or decreases in taxes. When government spending increases, the budget deficit rises, reducing the supply of loanable funds and increasing interest rates. This can crowd out private investment and lower economic growth. Similarly, a tax cut may increase consumption but reduce the supply of savings, again lowering the availability of loanable funds and crowding out investment. The author proposes an alternative simplified approach to demonstrate how a tax decrease could reduce total savings in the economy.

Uploaded by

Minh Châu Tạ Thị
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Xuan Lam, Nguyen

The logic of crowding-out effect

Case 1: An increase in government spending

G ↑ → B = T - G = SG ↓ → SG + SP = S ↓ → Supply of loanable funds ↓ → r (price of

K Y
loanable funds) ↑ → I ↓ (crowding-out effect) → K ↓ → ↓→ ↓→Y↓→
L L

GDPR ↓ → g ↓

Case 2: A tax cut

T ↓ → B = T - G = SG ↓ → SG decreases $1 as T decreases $1 (1)

T ↓ → (Y - T) ↑ → C ↑ → Due to household saving, C increases less than $1 as T

decreases $1 → Y - T - C = SP increases less than $1 (2)

(1) and (2) → SG + SP = S ↓ → Supply of loanable funds ↓ → r ↑ → . . .

I propose a shortcut alternative as follows:

T ↓ → (Y - T) ↑ → C ↑ (3)

SG + SP = (T - G) + (Y - T - C) = Y - G - C = S (4)

(3) and (4) → S ↓ → Supply of loanable funds ↓ → r ↑ → . . .

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