Question

what are the short term and long term affects of increased government spending?

Answer 1

Increased government spending is a tool of government's expansionary fiscal policy which leads to an increase in real output however and has a different impact in the short run and in the long run.

Short term impact-In the short run, the government will use this policy when the economy is going through a recession. The increase in government spending will lead to an increase in investment which increases the demand for labor and the output increases at an increasing rate. There would be rapid industrialization, an increase in employment, investment, consumption and real output which leads the economy to grow at a higher rate as the aggregate demand will increase.

Long term impact-In the long run, there would be pressure on the policy based n how the government financed its policy. As if successful the policy would lead to an increase in productivity but if there is no innovation then it will mean that the technology being used does not change which will not result in an increase in labor productivity. Usually the government finance it's spending through public debt which it will have to pay in the long run that means an increase in repayment of loans through interests or it raises taxes which will lower the aggregate demand. There is also the problem of crowding out if the economy is close to full capacity and which lowers savings so the spending may lead to inflation or lead to economic growth. There would be a problem of rising inequality as there would be more demand for high skilled workers than low skilled workers so it would lead to rising unemployment.