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    Selling Bonds vs. Printing New Money to Cover a Defecit

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    4) Suppose the government proposes to cut taxes while maintaining the
    current level of government expenditures. To finance this deficit, it may either
    a) sell bonds to the public, or, b) print new money (via Federal reserve cooperation).

    -What are the likely effects of each of these alternatives on each of the following?
    a) interest rates
    b) consumer spending
    c) business investment
    d)aggregate demand.

    Would Keynesians , monetarists, and supply-siders give the same answers?

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    Solution Preview

    Sell the bonds to the public:

    a) Interest rates will go up. There are more bonds available in the market than the investors are willing to invest in at the current interest rate. To attract more people to the bond market, the Goverment has to increase the interest rates.

    b) Consumer spending: With lower taxes, the purchasing power of people will increase so the consumer spending will increase. However at the same time, the interest rates will go up, so their will be temptation to save and invest in the bonds. So their will be a trade of for the individuals. Overall, the consumer spending will increase to a certain (part of tax savings made) extent and the savings will also incraese.

    c) As the tax rates are down, the incentive to invest in the new business opportunities are ...

    Solution Summary

    Consumer spending questions are posed.