With a lower interest rate, that incentive no longer exists and this is usually an instrument by which private entities can be driven out of saving and into investing into new business on the market. Obviously, such an action usually creates the appropriate momentum for economic development, creating jobs, increasing governmental revenues through revenues from taxation and helping the country out of the economic recession.
In terms of fiscal policies, the measures that the government needs to take will all attempt to move the IS curve further to the right and, in this sense, to stimulate the national economy, reduce the period that the country will pass through the recession and determine a national economic growth. There are two important means by which this can be done: increased governmental spending and decreased taxes, with a less restrictive taxation policy. As we can see on the IS - LM graph, both of these measures will move the IS curve to the right.
First of all, an increased governmental spending is a mean by which new jobs can be created and unemployment can be kept low. Governmental intervention in this direction can manifest itself, for example, by new construction projects, including new roads or buildings. While on one hand, this stimulates employment, as individuals will need to be employed in order to complete these public projects, on the other hand, these are also the types of projects likely to stimulate the economy in its entirety and be useful for economic development in the long run.
Second, a decrease in taxation levels, also...
Because of lower taxation levels, they will be more inclined to use their savings to create their own businesses rather than to save the respective values. This will create the right momentum for the aggregate economy as well.
As we can see from the previous explanations, the desired consequences for the monetary and fiscal policies previously presented would be for the U.S. To come out of the economic recession it is currently going into. However, some of the short-term effects may not necessarily point out in this direction. For example, decreasing the interest rates may also lower the incentive for foreign investors to spend money on the U.S. market, with a direct impact on the dollar. Nevertheless, in the long run, a weak dollar is likely to have a positive effect, because it will make exports cheaper and will reduce the current account deficit.
On the other hand, the fiscal policy characterized by low taxation levels and increased governmental spending is likely to create the premises for an economic recovery in the long-term. As we have seen, such fiscal measures will create incentives for businesses to pick up and will compensate the potential losses that current businesses are likely to incur, mainly due to pressures because of the economic recession, low demand on the market and higher costs of production. The final objective of both monetary and fiscal policies are to pull the country out of the economic recession.
