How does fiscal policy affect interest rates?
Just looking to get a general understanding if anyone could share thoughts. Does it all tie to the aggregate demand curve? Could someone expand on this or show me what I’m missing. Thanks
I’m sure your Econ professor that assigned this PSET would have a much better answer to this than your run-of-the-mill WSO bro
The Fed chooses what rates are, and if fiscal policy is highly accommodating they may decide to raise rates sooner. The rates in the market are really just people's expectations of what the Fed will do. There is no S/D channel like what you learn in intro econ courses, in our world of abundant reserves that's not really a thing anymore.
Lowering taxes is, in a sense, analogous to cutting interest rates; in both cases, money is being pumped into the system — the former via cash and the latter via credit. So, for instance, if you lowered taxes, and the added money in the system increased inflation to an undesirable level, you might have to raise interest rates (or raise taxes). Today most facets of monetary policy (cutting interest rates, QE, etc) are becoming increasingly less effective as a result of systematic deflationary phenomena like technology, globalization, and chiefly the disproportionate amount of savers relative to borrowers, a symptom of the Baby-Boomer-induced population imbalance of elderly people (more old people who tend to save rather than spend/borrow). When monetary policy loses its efficacy, we must turn to fiscal stimulus.
Thus, in the coming years there must be a careful coordination between monetary and fiscal policy if the U.S. wants to successfully deleverage. The trouble is that, going forward, the ones with their hands on the dials of our economy will be politicians.
Everything is cyclical; we saw this play out in the 1930-1945 period in the U.S., where interest rates hit zero and we turned to fiscal stimulus — to FDR and congress via a multitude of government stimulus programs. We are seeing the same thing play out today with stimulus checks.
A lot of very bad answers above. Just read this: https://fas.org/sgp/crs/misc/R45723.pdf
What is this crap. Basically just paraphrasing Mankiw who doesn't know what's going on. Ultimately rates go where the Fed wants them to, that's not what you'll learn in econ classes but that's how the world works. Look at the past 10 years and explain to me how massive deficits, low rates, and record levels of personal savings make sense in Mankiw's fictional world.
The OP question is how does fiscal policy affect rates. The FED manages monetary policy, not fiscal policy. It sounds like you have a problem understanding the question.
Ask stupid questions, get stupid answers
Ricardian Ambivalence
Edit: you're an idiot and don't understand the nuance of my statement to down vote
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