Answer to Question #187934 in Macroeconomics for John

Question

Congress just passed close to a $2 Trillion dollar increase in government spending that will be funded by borrowing and going into debt: 

How will this impact U.S. national savings, investment, capital per worker, output per worker and the steady state in Solow’s Growth Model. Make sure to include an intuitive and graphical analysis as well as the policy recommendations in Solow’s growth model.  

Draw Solow's growth model

Answer 1

Solow growth model gives the relationship between output growth of the economy and saving rate. It also tries to derive steady state capital per capita at different levels of population growth rate, saving rate, depreciation rate and rate of technological change.

When the government increases its spending by $2 trillion through borrowing. Then empirical evidences suggests that due to the increase in borrowing, the saving behavior of people rises. The saving rate rises in the economy consequently consumption will fall and at the same time the capital investment in the economy will rise. This leads to higher growth rate of the economy. Hence, in short run growth rate of economy will rise according to solow growth model.

Solow model graph

The solow model graph shows that as saving rate rises the investment curve goes up and because of this steady state, capital per capita as well as output per capita both rises.