Macroecon Act 1

https://www.economicshelp.
org/blog/102/interest-rates/effect-of-interest-rates-on-savers-and-
economy/
http://www.bsp.gov.ph/monetary/glossary.asp
Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government
spending, shifting the aggregate demand curve to the right.
Some people complain at times that interest rates are too high, thereby discouraging
investment. Others complain that interest rates can be too low, thereby discouraging
savings. There is no right interest rate, however. Interest rates are simply market
prices that help allocate credit based on risk, taxes, and individual preferences for
current and future consumption.
Government tax and spending policies simultaneously penalize savings and remove
the incentives to save. The two biggest culprits are the current tax code and the Social
Security system.
xpansionary fiscal policy:

fiscal policy that increases the level of aggregate demand, either through increases in
government spending or cuts in taxes
Take, for example, a high interest rate. At a high interest rate, it is very expensive to
borrow money: investors will not want to invest because they have to pay a lot of
interest on their loans. Savers, on the other hand, love high interest rates: they earn a
lot simply by keeping their cash in the bank. High interest rates encourage savings and
discourage investment.
In order to discourage savings, the Bangko Sentral ng Pilipinas which is the central
bank of the Philippines, could impose the Expansionary Monetary Policy. With the said
policy, savers will not be able to earn much by keeping their money in the bank because
of cut or decline in interest rates that reduces the rewards of savings and therefore
making savings account less attractive.
The precise opposite is true for low interest rates. When rates are low, investors know
they can borrow money to finance investments cheaply. At the same time, savers aren’t
earning much by keeping their money in the bank. Low interest rates encourage
investment and discourage savings.
Expansionary fiscal policy increases the level of aggregate demand, through either
increases in government spending or reductions in taxes. Expansionary policy can do
this by:
1. increasing consumption by raising disposable income through cuts in personal

income taxes or payroll taxes;
2. increasing investments by raising after-tax profits through cuts in business taxes;
and
3. increasing government purchases through increased spending by the federal
government on final goods and services and raising federal grants to state and
local governments to increase their expenditures on final goods and services.
Contractionary fiscal policy does the reverse: it decreases the level of aggregate
demand by decreasing consumption, decreasing investments, and decreasing
government spending, either through cuts in government spending or increases in
taxes. The aggregate demand/aggregate supply model is useful in judging whether
expansionary or contractionary fiscal policy is appropriate.
Consider first the situation in Figure 2, which is similar to the U.S. economy during the
recession in 2008–2009. The intersection of aggregate demand (AD0) and aggregate
supply (AS0) is occurring below the level of potential GDP. At the equilibrium (E0), a
recession occurs and unemployment rises. (The figure uses the upward-sloping AS
curve associated with a Keynesian economic approach, rather than the vertical AS
curve associated with a neoclassical approach, because our focus is on
macroeconomic policy over the short-run business cycle rather than over the long run.)
In this case, expansionary fiscal policy using tax cuts or increases in government
spending can shift aggregate demand to AD1, closer to the full-employment level of
output. In addition, the price level would rise back to the level P1 associated with
potential GDP.
Figure 2. Expansionary Fiscal Policy. The original equilibrium (E0) represents a recession, occurring at a
quantity of output (Yr) below potential GDP. However, a shift of aggregate demand from AD 0 to AD1, enacted
through an expansionary fiscal policy, can move the economy to a new equilibrium output of E 1 at the level of
potential GDP. Since the economy was originally producing below potential GDP, any inflationary increase in
the price level from P0 to P1 that results should be relatively small.
Should the government use tax cuts or spending increases, or a mix of the two, to carry
out expansionary fiscal policy? After the Great Recession of 2008–2009, U.S.
government spending rose from 19.6% of GDP in 2007 to 24.6% in 2009, while tax
revenues declined from 18.5% of GDP in 2007 to 14.8% in 2009.
This very large budget deficit was produced by a combination of automatic stabilizers
and discretionary fiscal policy. The Great Recession meant less tax-generating
economic activity, which triggered the automatic stabilizers that reduce taxes. Most
economists, even those who are concerned about a possible pattern of persistently
large budget deficits, are much less concerned or even quite supportive of larger budget
deficits in the short run of a few years during and immediately after a severe recession.

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xpansionary fiscal policy:

1. increasing consumption by raising disposable income through cuts in personal

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