Infrastructure Spending Fights a Recession
Government spending on infrastructure rises during a recession, and the spending multiplier magnifies the initial increase in G.
Infrastructure Spending Fights a Recession
Fiscal Policy (AD-AS)Government spending on infrastructure rises during a recession, and the spending multiplier magnifies the initial increase in G.
Equilibrium at Real GDP (Y) 92, Price Level (PL) 66
A recessionary gap
The economy starts with AD crossing SRAS to the left of LRAS, so real GDP sits below the full-employment level of output and unemployment is above its natural rate. That shortfall is a recessionary gap. Nothing has been done about it yet, and every move that follows is measured from this starting point.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Students predict what happens before the graph moves. No accounts, nothing graded.
Infrastructure Spending Fights a Recession, step by step
- 1
A recessionary gap
The economy starts with AD crossing SRAS to the left of LRAS, so real GDP sits below the full-employment level of output and unemployment is above its natural rate. That shortfall is a recessionary gap. Nothing has been done about it yet, and every move that follows is measured from this starting point.
- 2
Government spending rises
Government spending (G) is a component of aggregate demand, so an infrastructure program raises spending on domestic output at every price level and AD shifts right. The first dollar is not the last: construction firms and their workers spend part of the money again, and the households they pay spend part of that. The spending multiplier, 1/(1 - MPC), magnifies the initial increase in G, so AD shifts right by more than the sum Congress approved. No production cost has changed, so SRAS stays where it is.
- 3
The gap closes and prices rise
AD now crosses the unchanged SRAS at a higher real GDP and a higher price level, and output has climbed back to about the full-employment level marked by LRAS. The recessionary gap is closed and unemployment falls back toward its natural rate. Closing a gap from the demand side always costs something, because the price level rises along with output. Demand-side stimulus buys back jobs and output, and it pays for them with inflation.
- 4
Beyond what the graph shows
The graph stops at the short-run result. The deficit that paid for the program still has to be borrowed, and heavier government borrowing can raise interest rates and crowd out private investment. That effect belongs on the loanable funds market and is not drawn on the AD/AS graph in front of you.
Where it ends up
Expansionary fiscal policy raises G, and the spending multiplier makes AD shift right by more than the initial outlay, so real GDP and the price level both rise as the recessionary gap closes.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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