Fiscal Policy

发布时间:2016-3-19 | 杂志分类:其他
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Fiscal Policy

!1Xu, Bena) Explain how fiscal policy helps to resolve problems arisen from recession.Recession refers to a period of two or more consecutive quarters of decreasing GDP,exemplified by the Great Depression, during which the US experienced a three-yeardecline of GDP up to 30%. GDP is the total value of all final goods and servicesproduced in an economy during a given period. It is the output produced whenaggregate demand equals aggregate supply, i.e. when the total amount of goods andservices dema... [收起]
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Fiscal Policy
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!1

Xu, Ben
a) Explain how fiscal policy helps to resolve problems arisen from recession.

Recession refers to a period of two or more consecutive quarters of decreasing GDP,
exemplified by the Great Depression, during which the US experienced a three-year
decline of GDP up to 30%. GDP is the total value of all final goods and services
produced in an economy during a given period. It is the output produced when
aggregate demand equals aggregate supply, i.e. when the total amount of goods and
services demanded and that supplied in an economy during a given period are equal.

!
During a recession, there is a deflationary gap—the real GDP, Y1, produced when
AD=SRAS, is lower than the potential GDP, Yf, the level of output when the economy
is at full employment). Less output means low or negative economic growth and more
unemployment, which are undesirable for the economy.

Government can tackle recession through the use of expansionary fiscal policy, a
demand-side policy in which the government increases its own expenditures and/or
decreases taxes to increase aggregate demand, thus increasing real GDP and closing
the deflationary gap. Aggregate demand consists of the demand of consumers (C),
firms (I), government (G), and net export (X-M). The increase in government
expenditures directly increases (G). The decrease in personal tax increases the
disposable income of consumers, who now have more money to consume, thus
increasing (C). The decrease in business tax encourages investment (I), as firms now
have high returns due to a decrease in tax. Increases in G, C, and I shift the AD curve
to the right, increasing the real GDP to Yf, the potential GDP, thus resolving the
recession.
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!2

Xu, Ben

b) Evaluate the use of fiscal policy.

The use of fiscal policies to resolve economic fluctuations has both advantages and
disadvantages.

First, it is direct and instantly effective if implemented. This is especially true when
government increases its expenditures, which directly increases the G component in
aggregate demand, pulling the economy out of recession in time. This is a great
advantage when compared to monetary policy, as banks might be unwilling to lend
for the fear of insolvency of firms during deep recession, and interventionist policy,
which might take a long period of time to realize its effect.

!
Besides, when the government increases its expenditures on human capital, such as
education, and infrastructure, such as urban transportation, it not only increases
aggregate demand, but also helps achieve economic growth and increase production
possibilities in the long term, demonstrated by the outward movement of the
production possibility curve due to improvement in resource (human and physical)
quality.

!
Moreover, it enjoys the multiplier effect, the magnification of the change in aggregate
demand due to induced spending; the government expenditures become incomes of
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!3

Xu, Ben

other people, who use the money to increase consumption. Thus, the shift in AD is

often greater than the amount of increase in government expenditures, as illustrated

on the diagram.

However, the hard-to-measure multiplier effect makes it difficult to “fine tune” the

economy. Compared with monetary policy, which can adjust interest rates

incrementally, government expenditures are often of large amount, and tax

adjustments are unlikely to be done on a constant basis. Thus, the use of fiscal policy

might not help the economy reach the precise target of level of output.

!
Furthermore, the crowding out effect induced by expansionary fiscal policy might
offset its effect. During recession, the policy usually has to be implemented under
deficit spending, in which government increases its expenditures by issuing bonds to
borrow money from the public, decreasing the loanable funds available in the
economy. This is illustrated by a leftward shift of the supply curve of loanable funds,
which in turn drives up the real interest rate from I1 to I2, causing the money borrowed
by consumers and firms for consumption and investment to decrease from Q1 to Q2,
which results in a decrease in AD.

Finally, the use of fiscal policy might be manipulated by politics, which could be
economically unfavorable. While increase in government expenditures on public
services and tax cuts are politically popular, they might be unnecessarily enacted only
to win people’s favor, especially during elections. Also, the bureaucratic nature of
fiscal policy often leads to a long time lag before it goes into effect, which could
make the passed policy irrelevant at the time of implementation.
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