Reference no: EM131517992

Fiscal policy is meant to return the economy back to its potential GDP where employment is at the "natural" rate and the price levels are at an acceptable level. As you shared, when the economy is producing below its capacity (where aggregate demand is low and unemployment is high), the government either injects more money in the economy through increased spending on goods, services, and/or transfers (such as unemployment benefits or welfare), or it reduces taxes (which leaves people with more money to spend). For example, and as you shared, when the government spends money on upgrading the infrastructure, more jobs will be created and more goods and services will be demanded and produced, and thus more workers will be needed to produce those goods and services. The aim is to increase the supply side in the economy (production and work).

If the government's aim is to reduce unemployment through increasing its spending or decreasing taxes, the total revenue the government receives and maintains declines (fewer income taxes collected). The decline in government revenue might cause it to have a budget deficit. When the government runs a budget deficit, it needs to borrow the money (increase in demand for loans) to maintain its spending and to implement expansionary polices.

Discuss the effects of government budget deficit on interest rates, investment, GDP, and net trade.