If the government persistently runs a budget deficit, government debt will rise. If this debt rises faster than GDP, then it will account for a growing proportion of GDP.

If the government persistently runs a budget deficit, government debt will rise. If this debt rises faster than GDP, then it will account for a growing proportion of GDP. There is then likely to be an increasing problem of ‘servicing’ this debt, i.e. paying the interest on it. What effects will government investment expenditure have on general government deficits in the short run and in the long run

Expert Solution

1.Effect of government investment expenditure on general government deficits in the short run and long run.

The government investment strongly affects aggregate demand and aggregate supply by providing the additional capital factor both in the short run and in the long run which in turn attracts foreign direct investments and expansion of export oriented growth bringing down government deficits.It has to be noted that increase in both aggregate demand and aggregate supply of the economy is the key to impact the reduction in the gvernment deficits.

Public investment has the crowding in effect on private investment in the short run and crowding out effect in the long run.In the short run Government investment expenditure brings about more capital in the form of more infrastructure, also it increases money supply through income generation and that leads to increase in aggregate demand for goods and servces.It in turn induces private investment along with foreign direct investments which in turn expands the economy ensuring more employment,more production, more income more exports, more taxes to the goverment thereby reducing general government deficit.

But in the long run excessive government investment expenditure has a crowding out effect due to the distortion of prices i.e.servicing the public debt might require for more taxes,increase in aggregate demand will increase the price levels, increase in interest rates etc will make private investments unattractive,and will result in loss of employment ,reduction in aggregate demand and supply leading to higher deficit persisting.

So the bottomline is that the economy has to ensure higher growth rate of GDP than the rate of increase in the government deficit so that there will be a gradual reduction in debt GDP ratio.

Rahul Sunny answered 2 years ago

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