Will increases in federal spending always increase real GDP and employment in the short run? Why or why not? Explain.

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Business

Jaslyn Rasmussen

7 August, 06:22

Will increases in federal spending always increase real GDP and employment in the short run? Why or why not? Explain.

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Answers (1)

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Cali Mueller · Answer 1

Increase in government spending may lead to crowding out of private investment causing a reduction in the real GDP and employment.

Explanation:

An increase in government spending does not always lead to an expansion in the economy. The increase in government spending generally causes an increase in aggregate demand thus increasing output and employment.

Though, it may also lead to crowding out of the private investment. When the increase in spending is financed through borrowing, it would increase the interest rate because of the increase in demand for loanable funds. This would cause a reduction in private investment. Consequently, aggregate demand will decrease leading to a decrease in real GDP and employment.