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Explain what is meant by the expression 'crowding out' and then use the IS/LM model for a small open economy to show how an expansionary fiscal policy in a situation of floating exchange rates may crowd out net exports.
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Macroeconomics essay Explain what is meant by the expression 'crowding out' and then use the IS/LM model for a small open economy to show how an expansionary fiscal policy in a situation of floating exchange rates may crowd out net exports. To understand the concept of crowding out, we need to analyse the demand for goods and services, and what determines this demand. The level of demand in an economy is determined by four components, consumption, investment, government purchases, and net exports. To explain crowding out, I will look at a closed economy, which means net exports do not need to be considered. The important factors which do need to be considered when explaining crowding out are investment, and government purchases. The following diagram illustrates the relationship between the level of savings and investment, and interest rates. Investment, which is equal to income minus consumption and government purchases, increases as the interest rate...
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