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Explaining the Relationship between Stimulus and Spending in Economic Growth

Explaining the Relationship between Stimulus and Spending in Economic Growth

Let’s say that private gdp is 100 and government spending is 100.  Gdp then suddenly goes up to 200, so government spending as a percentage of gdp falls from 50% to 33.3%.  This is not a contractionary event.  It is fully possible to argue “government spending should go up too, to slot more public goods into the larger output,” but the initial change is expansionary, even though government spending as a percentage of gdp took a steep dive.

Let’s say that private gdp is 100 and government spending is 100.  Government spending stays the same in nominal terms but there is overall price inflation from a nominal change.  It is fully possible to argue “government spending should go up too, to restore the percentage of public goods in national output,” but the initial change is again expansionary in macroeconomic terms.  Nominal values are up.

In other words, when judging whether fiscal policy is contractionary or expansionary in macroeconomic terms, we do not automatically adjust for percentage of gdp and inflation.  Start instead by looking at nominal government spending, and then perhaps take a glance at nominal gdp or related measures.  The theory, after all, is about nominal values, most of all in the short run.

If you wish, I could construct a similar exercise for population or an increase in the labor force and come out with a similar result.

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