AP Macroeconomics Unit 5 Essentials

Real GDP in the long run is anchored by resources and technology, not by how much money is circulating. When the central bank grows the money supply faster than the economy's real growth rate, the extra money doesn't buy more real goods and services — it just bids up prices. This is why hyperinflation episodes throughout history are almost always traced back to a government printing money far faster than the real economy was growing.

In the short run, unexpected inflation can temporarily lower unemployment — but only because people are surprised. Once workers and firms come to expect that inflation rate, they build it into wage and price decisions, and the temporary boost to employment disappears, leaving the economy back at the natural rate of unemployment but with permanently higher inflation. This is the entire logic behind why the long-run Phillips curve is vertical: you cannot fool people indefinitely.

A budget deficit financed by borrowing doesn't disappear — it accumulates into the national debt, and that debt has to be financed by competing with private borrowers for loanable funds. Sustained deficits raise real interest rates and can crowd out the private investment that builds tomorrow's capital stock. The long-run consequence of persistent borrowing isn't felt today — it shows up years later as slower capital accumulation and reduced growth potential.