Final answer:
If an increase in government expenditures is matched by higher taxes, the impact on aggregate demand may be neutral. If funded by federal borrowing, it could increase aggregate demand but may lead to crowding out, higher interest rates, or trade imbalances. Distribution effects also play a role.
Step-by-step explanation:
If an increase in government expenditures is financed by an equal increase in taxation, this action is likely to have a neutral impact on overall aggregate demand in the economy. This is because the money is being transferred from taxpayers to the government, and then spent on goods and services, thus potentially offsetting each other. However, the specific impact may depend on how the government allocates that spending and the propensity to consume of the taxpayers versus the beneficiaries of government spending.
On the other hand, if the same increase in government expenditures is financed by additional borrowing by the federal government, it could lead to an increase in aggregate demand. This is because government borrowing could lead to more spending without the immediate offset of higher taxes. However, this could also impact national saving, potentially leading to less private investment (crowding out), higher interest rates, and/or larger trade imbalances.
The impact on distribution of income and shifts in which part of the economy benefits, such as spending on defense or aiding certain groups like farmers, is also a consideration when examining the effects of changes in fiscal policy.