Predict: Big Government Stimulus

The facts

The economy starts in a normal, balanced state.
Government spending rises from 22% to 27% of GDP.
Tax rates stay the same, and the Fed keeps its rate unchanged.

Your predictions

What happens to GDP growth in the short run?

▲ Goes up ● About the same ▼ Goes down

What happens to unemployment?

▲ Goes up ● About the same ▼ Goes down

What happens to the federal budget deficit?

▲ Goes up ● About the same ▼ Goes down

What happens to long-term (10-year) bond rates?

▲ Goes up ● About the same ▼ Goes down

Playing it out…

Why?

Government spending adds directly to aggregate demand (C + I + G + NX), so GDP growth jumps and unemployment falls. Because taxes did not rise, the deficit widens and the government must borrow more — which pushes up long-term interest rates. Higher rates can “crowd out” some private investment, and extra demand also nudges inflation up.

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