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Unformatted text preview: What really happens, then, when the Fed and the government use monetary policy and fiscal policy? If we recall the equation for output of Y = C(Y - T) + I + G + NX we can begin this analysis. Given that Y is fixed by the factors of production, a change in G or T--that is, fiscal policy--must result in a change in another variable to maintain a constant Y. This change in Y works directly though the interest rate. Each of the variables in the output equation is tied to the interest rate. Consumption tends to fall as the interest rate rises because the incentive for saving increases. Investment tends to fall as the interest rate rises because the cost of borrowing money increases. Government spending is not really affected by the interest rate. Net exports tend to rise as interest rates rise because domestic investment is relatively more...
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This note was uploaded on 12/13/2011 for the course ECO 1310 taught by Professor Staff during the Fall '10 term at Texas State.
- Fall '10