2. Suppose the economy is in a slump and the current public debt is quite large. Explain the trade-off of short-run versus long-run objectives that policy makers face when deciding whether or not to engage in deficit spending.
In order to stimulate the economy in the short run, the government can use fiscal policy to increase real GDP. This entails borrowing, increasing the size of the public debt further and leading to undesirable consequences: in extreme cases, governments can be forced to default on their debts. Even in less extreme cases, a large public debt is undesirable because government borrowing crowds out borrowing for private investment spending. This reduces the amount of investment spending, reducing the long-run growth of the economy.