Question

If the federal government is reducing net taxes to stimulate the economy at the same time the Fed is selling bonds in the open market, the effectiveness of the expansionary fiscal policy will be

1. increased, because the Fed's actions will result in higher interest rates.

2. reduced, because the Fed's actions will result in higher interest rates.

3. increased, because the Fed's actions will result in lower interest rates.

4. reduced, because the Fed's actions will result in lower interest rates.

Answer 1

Option 3

3. increased, because the Fed's actions will result in lower interest rates.

the reducing taxes increases aggregate demand and shifts the demand curve to the right which increases price level and that increases interest rate so the crowding-out effect decreases the effect of the fiscal policy so an expansionary monetary policy that increases the money supply and decreases interest rate which reduces the crowding-out effect and increases the effect of the fiscal policy.