Question

5) Suppose consumption and investment both heavily depend upon interest rates. Explain why fiscal policy would then be less effective at getting the economy out of recession.

Answer 1

As consumption and investment both heavily depend upon interest rates, fiscal policy would be less effective at getting economy out of recession because, fiscal policy affects the economy by varying the percentage of revenue through varying tax and by changing the percentage of its expenditure.

Both of these things wouldn't have any major impacts over money supply, as the money supply depends on the rates of interest and to vary the rate of interest, the sole authority lies with the central banks through monetary policy.

Central banks opts for expansionary monetary during recession to increase the money supply in market, as in expansionary monetary policy, interest rates are kept low which in turn increases the money supply in the market increasing both the rate of consumption and investment.