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At this point, you may wonder about the Federal Reserve . After all, can the Federal Reserve not use expansionary monetary policy to reduce interest rates, or in this case, to prevent interest rates from rising? This useful question emphasizes the importance of considering how fiscal and monetary policies work in relation to each other. Imagine a central bank faced with a government that is running large budget deficits, causing a rise in interest rates and crowding out private investment. If the budget deficits are increasing aggregate demand when the economy is already producing near potential GDP, threatening an inflationary increase in price levels, the central bank may react with a contractionary monetary policy    . In this situation, the higher interest rates from the government borrowing would be made even higher by contractionary monetary policy, and the government borrowing might crowd out a great deal of private investment.

On the other hand, if the budget deficits are increasing aggregate demand when the economy is producing substantially less than potential GDP, an inflationary increase in the price level is not much of a danger and the central bank might react with expansionary monetary policy    . In this situation, higher interest rates from government borrowing would be largely offset by lower interest rates from expansionary monetary policy, and there would be little crowding out of private investment.

However, even a central bank cannot erase the overall message of the national savings and investment identity. If government borrowing rises, then private investment must fall, or private saving must rise, or the trade deficit must fall. By reacting with contractionary or expansionary monetary policy, the central bank can only help to determine which of these outcomes is likely.

Public investment in physical capital

Government can invest in physical capital directly: roads and bridges; water supply and sewers; seaports and airports; schools and hospitals; plants that generate electricity, like hydroelectric dams or windmills; telecommunications facilities; and weapons used by the military. In 2014, the U.S. federal government budget for Fiscal Year 2014 shows that the United States spent about $92 billion on transportation, including highways, mass transit, and airports. [link] shows the total outlay for 2014 for major public physical capital investment by the federal government in the United States. Physical capital related to the military or to residences where people live is omitted from this table, because the focus here is on public investments that have a direct effect on raising output in the private sector.

Grants for major physical capital investment, 2014
Type of Public Physical Capital Federal Outlays 2014 ($ millions)
Transportation $91,915
Community and regional development $20,670
Natural resources and the environment $36,171
Education, training, employment, and social services $90,615
Other $37,282
Total $276,653

Public physical capital investment of this sort can increase the output and productivity of the economy. An economy with reliable roads and electricity will be able to produce more. But it is hard to quantify how much government investment in physical capital will benefit the economy, because government responds to political as well as economic incentives. When a firm makes an investment in physical capital, it is subject to the discipline of the market: If it does not receive a positive return on investment, the firm may lose money or even go out of business.

Questions & Answers

what is the Invisible Hand?
adrian Reply
What are the limitations of a commercial Bank to create credit
Tanyi Reply
what is meant by efficiency of labour
Fritz Reply
production possibility curve
Mama Reply
graphs about production possibility curve?
Mama
I cant open the links in the text.
adrian
what are the concept of economic
dauda Reply
demand suply and population
dauda
graphs on about ppc
Mama
with the aid of diagrams illustrate movement along and shifts in demand curve
Mercy Reply
what is scarcity
ISAH Reply
limited in supply relative to demand
doris
scarcity means resources available to provide our daily needs are limited
Terkimbi
shortage of resources that we need for our demand. basically price go up due to this problem.
Jean
scarcity means our resources r not enough for us or our resources r limited
Adam
discuss the effects of price controls int the economy
Charmaine
• It stimulates excess demand, which cannot be statified ie shortage in the market. • It encourages hoarding of commodities by wholesales and retailers. • It leads to the creation of " black market" or undercounter sales and its attendant high prices. • It encourage conditional sales of products.
BAMBA
on how scarcity,choice and opportunity cost work together
Livin
means less than requirement
Livin
What are the reasons for the existence of monopoly?
Gerry Reply
Because such barriers occur in different forms, there are therefore varying reasons for the existence of monopolies. Ownership of a Key Resource: When one company exerts sole control over a resource that is necessary for the production of a specific product, the market may become a monopoly.
Kenneth
Thanks Kenneth
Gerry
what is international trade
Syed Reply
what is imperfect compition
Syed
what is crowding out effect
LAXMI Reply
what is federal finance?
LAXMI Reply
what is populic
Kute
what is imperfect compition
Syed
Explain five importance of the study of economic
Francis Reply
study of economics help a person to make rational choice in multiple wants. help individual to be a well all-round thinker.
Bitrus
the five important of the study of economics are as follows (1)time (2)management of resources (3)choice making (4)business(5)scarcity
Terkimbi
an increase in demand (while supply remains constant) what will happen to deh graph?
Thabiso Reply
what is going to happen to the graph if there is an increase in demand, While supply remains constant .
Thabiso
What will happen to the graph if there is an increase in demand While supply remains constant?
Thabiso
price will increase high than automatically demand will decrease
takshaveer
equilibrium ?
Issum
is when the supply and demand are balanced
ISAH
as demand increase and supply remain constant means the price will increase also
Livin
what is the difference between economic growth and economic development ?
yonas
What is black money
Abichu
what is demand
Sarkwah Reply
demand is the willingness to buy a commodity backed by the ability to pay.
Runwell
demand is mere desire on commodity with ability to back up with purchasing power
Terkimbi
demand is the want of commodity back by the ability to pay for that commodity
Adenira
demand is the willingness to buy any type of commodity for the exchange of something that is valuable to the seller.
Jean
demand is any valuable commodity that people are willing to buy at prices.
ISAH
Equilibrium is when there's an equality between quantity demanded and quantity supplied
Victory Reply
Again the consumer will be in equilibrium if the price of the commodity is equal to Marginal utility of that product
daniel

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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