In the long run, what effect does a government's deficit spending have on equilibrium real Gross Domestic Product (GDP)?
A) The government's deficit spending will increase equilibrium real Gross Domestic Product (GDP).
B) Deficit spending will decrease the nation's equilibrium real Gross Domestic Product (GDP).
C) Higher government deficits will not raise equilibrium Gross Domestic Product (GDP) above the full-employment level.
D) Equilibrium real Gross Domestic Product (GDP) will increase beyond the full-employment level and there will also be an inflationary effect.

Question

Quizplus · Accepted Answer

Higher government deficits will not raise equilibrium Gross Domestic Product (GDP) above the full-employment level. While deficit spending may temporarily increase GDP by stimulating demand, it is unlikely to have a sustained impact on equilibrium GDP in the long run. Eventually, the government will have to raise taxes or cut spending to pay off the debt, which will reduce demand and offset any initial stimulus from deficit spending. Additionally, if the deficit spending leads to inflationary pressures, the central bank may raise interest rates, which will also reduce demand and weaken GDP growth. Therefore, in the long run, equilibrium GDP is unlikely to be significantly affected by government deficit spending.

In the Long Run, What Effect Does a Government's Deficit