Link 1:

Introduction

We are going to analyse the impact of an increase in government deficit on the interest
rate using loanable fund diagram.

explanation

a. If an economy experience a government deficit, then the demand for loanable fund
increases, leading to rightward shift in loanable fund curve as LD2. This will leads to
increase Interest from r1 to r2. An increase in govt liabilities exceeds the public revenue
leads to an increase in interest rate which in turn leads to to a reduction in private
investment.This is called crowding out effect in macro economics. During time of budget
deficit, the government adopt an expansionary policies to increase public spending, it
increase interest rate and reduce investment. Furthermore, a rise in interest rate will
create a lower demand for loanable funds. The high magnitude of crowding out may
cause a lesser income in the economy due to the diversion resources away from private
sector leads to lower economic growth.Thus, budget deficit leads to crowding out of
private investment but it stimulate private savings which in turn stimulate national
savings.

b. We know that deposit multiplier= 1/required reserve ratio. Ie, 1/10%

= 1/0.1= 10. If central bank purchase 3 million government bonds in open market, then
money supply increased by 10× 3 million= 30 million.

Conclusion
Thus, the open market purchase of bonds will increase money supply.
Link 2:

Philips curve shows inverse relationship between Inflation and unemployment. If

aggregate demand shifts right then it shows peoples confidence in an economy. Price
levels go up and also number of jobs are higher.

a. Less confidence in firms will produce less number of goods.

Aggregate supply shifts from AS1 to AS2 and hence inflation-unemployment in Philips
curve which was 2% and 5 % respectively will shift outwards from Short run Philips
curve (SRPC) to new SRP with more inflation and unemployment- say 4% and 8%
respectively. In short from point a to point b in Philips curve diagram.This has happened
as price levels went from P1 to P2 and real GDP shifted from Y1 to Y2 causing
unemployment to go up.

This shows stagflation in the short run.

b. Policies should focus on supply side.

Supply side policies: This policy focuses on aggregate supply. It has two types- market
based and interventionist based. market based policy focuses on incentives for
businesses, labor market reforms and encouraging competition. Interventionist based
policy focuses on human and physical capital.

Tax concessions can be given in short term.

All these factors will aim at shifting aggregate supply back to AS1 . This needs a longer
time.This will bring AS2 back to AS1 and Long run Philips curve is regained with Short
run Philips curve shifting back from point b to point a.