Which, if any, of the following statements is true? (a)Crowding-out refers to a situation in which an increase in government spending reduces the size of the multiplier. (b)An interest rate cut usually stimulate the aggregate demand through the investment channel. (c)The Phillips curve is a graphical demonstration of a positive relationship between inflation and unemployment. (d)The Okun’s law is a graphical representation of a negative relationship between inflation and unemployment. (e)The presence of taxes in the multiplier model tends to increase the size of the multiplier.
Which, if any, of the following statements is true?
(a)Crowding-out refers to a situation in which an increase in government spending reduces the size of the multiplier.
(b)An interest rate cut usually stimulate the aggregate demand through the investment channel.
(c)The Phillips curve is a graphical demonstration of a positive relationship between inflation and unemployment.
(d)The Okun’s law is a graphical representation of a negative relationship between inflation and unemployment.
(e)The presence of taxes in the multiplier model tends to increase the size of the multiplier.
The correct answer and explanation is:
Correct Answer:
(b) An interest rate cut usually stimulates the aggregate demand through the investment channel.
Explanation:
(a) Crowding-out refers to a situation in which an increase in government spending reduces the size of the multiplier.
This statement is partially correct but not entirely accurate in its explanation. Crowding-out occurs when increased government spending raises interest rates, discouraging private investment and reducing the overall effectiveness of fiscal policy. However, crowding-out does not directly “reduce the size of the multiplier”; rather, it dampens the total economic impact of fiscal expansion.
(b) An interest rate cut usually stimulates the aggregate demand through the investment channel.
This statement is correct. A reduction in interest rates decreases the cost of borrowing, encouraging businesses to invest in new projects and consumers to take on loans for big-ticket items, such as homes and cars. This rise in investment and consumption boosts aggregate demand, contributing to economic growth. Lower interest rates also make saving less attractive, further encouraging spending. This is a key mechanism in monetary policy aimed at stimulating economic activity.
(c) The Phillips curve is a graphical demonstration of a positive relationship between inflation and unemployment.
This statement is incorrect. The traditional Phillips curve shows a negative relationship between inflation and unemployment in the short run—when inflation rises, unemployment tends to decrease, and vice versa. In the long run, however, the Phillips curve becomes vertical as inflation expectations adjust, and no trade-off exists.
(d) Okun’s law is a graphical representation of a negative relationship between inflation and unemployment.
This is incorrect. Okun’s law describes the negative relationship between unemployment and real GDP growth, not inflation and unemployment. As output grows, unemployment typically falls, and vice versa.
(e) The presence of taxes in the multiplier model tends to increase the size of the multiplier.
This statement is incorrect. Taxes reduce the size of the multiplier because they decrease disposable income, limiting consumer spending and the subsequent rounds of economic activity that occur due to fiscal stimulus.
Thus, (b) is the only accurate statement among the options.