The diagram below is for a closed economy which begins in long-run equilibrium at Y* and . FIGURE 31-3
-Refer to Figure 31-3.Suppose the government implements an expansionary fiscal policy,which increases the budget deficit.The economy's adjustment process returns real GDP to Y* in the long run.Since real GDP is not affected in the long run,how are future generations likely to be harmed by this government policy?

Question

The diagram below is for a closed economy which begins in long-run equilibrium at Y* and  .  FIGURE 31-3
-Refer to Figure 31-3.Suppose the government implements an expansionary fiscal policy,which increases the budget deficit.The economy's adjustment process returns real GDP to Y* in the long run.Since real GDP is not affected in the long run,how are future generations likely to be harmed by this government policy?

Quizplus · Accepted Answer

An expansionary fiscal policy that increases the budget deficit may lead to an increase in interest rates, which crowds out private investment. This can lead to a lower future growth rate of potential GDP, thereby harming future generations. Choice A is not necessarily true as it depends on the specific spending choices made by the government. Choice C is not relevant as the question states that the economy returns to long-run equilibrium, meaning there is no inflationary gap. Choice D is not necessarily true as the impact of a budget deficit on the exchange rate is dependent on various factors. Choice E is not correct as any policy implemented by the government can have an impact on future generations, regardless of whether real GDP is affected in the long-run.

The Diagram Below Is for a Closed Economy Which Begins