Is constrained because those rates are already near

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is constrained because those rates are already near zero, as they are currently, the short-run effects ofchanges in government spending on output tend to be larger than usual.Nevertheless, changes in government purchases and transfers create demand-side effects that are usuallyonly temporary: They raise or lower output relative to what it would be otherwise only for a whilebecause, over time, stabilizing forces in the economy (such as the responses of prices and interest ratesand actions by the Federal Reserve) tend to move output back toward its potential. Over the long run, the nation’s potential to produce goods and services depends on the size and qualityof its labor force, on the stock of productive capital (such as factories, vehicles, and computers), and onthe efficiency with which labor and capital are used to produce goods and services.Changes in those determinants of potential output can have a lasting influence on the economy’s ability
to supply goods and services. Therefore, the federal government’s budgetary policies affect potentialoutput primarily by affecting the amount of national saving and the incentives for individuals andbusinesses to work, save, and invest. The nation’s capital stock depends both on public saving (thesurpluses, if any, of state and local governments and the federal government) and on private saving (byhouseholds and businesses). A federal deficit represents a reduction in public saving and, therefore, innational saving. An overall decline in national saving reduces the capital stock owned by U.S. citizensover time through a decrease in domestic investment, an increase in net borrowing from abroad, or both.Specific spending policies can also influence the economy’s potential output in other ways. Some typesof spending, such as funding for improvements to roads and highways, may add to the economy’spotential output in much the same way that private capital investment does. Other policies, such asfunding for grants to increase access to college education, may raise long-term productivity byenhancing people’s skills. The positive longer-term impact of deficit reduction on GNP would be smallerif the policies that reduced deficits included cuts in productive government investments.Even among types of federal spending that contribute to potential output, the Effects of different policiescan vary greatly. For example, spending for basic research and education may affect output only after anumber of years, but once those investments begin to boost output, they may pay off over more yearsthan would the average investment in physical capital (in economic terms, they may have a low rate ofdepreciation). Moreover, even within a specific program, how those funds are allocated also matters a great deal.Although some specific government investments in a particular category may be as productive as privateinvestment, other projects probably fall short of that benchmark. On a more fundamental level, the

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