The diagram below is for a closed economy which begins in long- run equilibrium at Y*.
FIGURE 32- 3
-Refer to Figure 32- 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*.
  FIGURE 32- 3
-Refer to Figure 32- 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

The expansionary fiscal policy results in an increase in the budget deficit which will lead to an increase in government borrowing. This can lead to crowding out of private investment, which will reduce the future growth rate of potential GDP. This can harm future generations as they will have a lower potential standard of living than they would have had if private investment had not been crowded out. Therefore, choice D is the best answer.

The Diagram Below Is for a Closed Economy Which Begins