Distinguish between fiscal policy during recession vs. inflation and explain crowding-out.

• A. Recession: increase G or reduce T; Inflation: decrease G or raise T; crowding-out occurs when higher government spending raises interest rates that crowds out private investment.
• B. Recession: decrease G; Inflation: increase T; crowding-out occurs when government spending reduces savings but not interest rates.
• C. Recession: use tight monetary policy; Inflation: use expansionary policy; crowding-out is when government spending increases deficits but not interest rates.
• D. Recession and inflation require identical policy; crowding-out is not related.

Answer: (A)

The main idea is how fiscal policy should respond to different economic conditions and how crowding-out works. In a recession, the goal is to boost demand, so policymakers typically use expansionary fiscal policy—spending more or cutting taxes—to push aggregate demand up. In contrast, when inflation is a concern, contractionary fiscal policy—spending less or raising taxes—helps cool demand and reduce the price pressure. Crowding-out explains why higher government spending financed by borrowing can reduce private investment: the government borrows more, increasing the demand for loanable funds and pushing up interest rates, which makes borrowing for private firms more expensive and can offset part of the stimulus. This combination—expansionary actions in a recession, contractionary actions during inflation, and crowding-out through higher interest rates—matches the best answer. The other options mix up the direction of policy, confuse monetary versus fiscal tools, or deny the link between deficits and interest rates.