Answer to Question #53356 in Microeconomics for Esther Arthur

Question

Suppose the federal government is running a large deficit but that aggregate demand is fairly high(with a fairly low level of unemployment and a moderate level of inflation). Further assume that the nation's infrastructure is in drastic need of large investment in repair and expansion. Recognizing that any further increases in AD will cause a real increase in inflation, what do you think the government should do to significantly increase expenditure on infrastructure without making the deficit on inflation worse?

Answer 1

If the federal government is running a large deficit but that aggregate demand is fairly high (with a fairly low level of unemployment and a moderate level of inflation), and if the nation's infrastructure is in drastic need of large investment in repair and expansion, then recognizing that any further increases in AD will cause a real increase in inflation the government should increase government spending with the simultaneous increase in taxes to significantly increase expenditure on infrastructure without making the deficit on inflation worse. In this case the rise of a deficit will be covered by the increased tax revenues.