Question

In the AS & AD model for the very short run (immediate short run AS) expenditure shocks operate as they did in the multiplier model (with magnified effects on real GDP). Explain why that analysis isn’t completely realistic for figuring out how much real GDP would ultimately respond to a trillion dollar increase in government spending at this particular moment in history (the US in 2019).   

Answer 1

Generally, immediate short-run AS curve is expected to be horizontal curve, such that an expenditure shock produces multiplier effect on real GDP.

However, in the year 2019, the global economy does not look very promising. There is recessionary pressure world-wide. The economies around the world are experiencing slowdown, thereby leading to absence of adequate impulse for demand for US goods. US government is in high public-debt situation. There is excessively high interest rate situation and fading of fiscal stimulus due to risk of burgeoning high debt. The private sector is less likely to bring up big investment projects. There is high level of inequality in the distribution of income and wealth in US economy. Thus, demand for goods from all sectors are not so robust. This led to rising level of unemployment. This also acts as a drag on aggregate demand growth. There is contraction of economy-wide spending relative to the economy’s potential productive capacity. The consumers (households, businesses, or governments) have started cutting back their spending to increase savings, thereby further resulting into less demand and less supply and vicious cycle of low demand and low supply.

Thus, multiplier effect as conceptualized in theory in the case of immediate short run aggregate supply with trillion dollar increase in government spending on real GDP is not realizable or figured out.