When the government deficit spends, its immediate effect is to shift aggregate demand to the right. However, it also increases the demand for loanable funds, increasing real interest rates. This leads to a decrease in interest-sensitive consumption and investment, and can slow economic growth in the long run.

(a) Congress passes a bill that requires an annual balanced federal budget. The government moves from a fiscal deficit to a balanced budget.

(b) Assume the federal budget is balanced when an increase in retirees rapidly expands those collecting Social Security retirement benefits at the same time that it decreases tax revenues from personal income taxes.

(c) Assume that fiscal receipts equal outlays when the Federal Reserve increases the discount rate.

(d) Assume that federal receipts exceed outlays by $70 billion when a recession occurs. The government collects $90 billion less in tax revenue than expected.

(e) Illustrate this economy's situation on a short-run and a long-run Phillip's curve. Label the short-run equilibrium point R.

(f) What type of fiscal policy could address the economic situation from part (e)?

(g) Assume the federal budget is balanced when the policy from part (f) is implemented. On a fully labeled loanable funds graph, illustrate the impact of this policy on real interest rates.

(h) Will the policy from part (f) cause crowding out? Explain.

(i) Assume that the Federal Reserve takes a policy action to keep interest rates low. Illustrate the impact of this action on a fully labeled money market graph.