Expansionary Economic Policy
ECO203: Principles of Macroeconomics
April 14, 2013
In economic terms, a recession is defined as a general slowdown in economic activity. In an effort to move the economy out of a recession, the government would implement expansionary economic policies. One action the government would take would include conducting expansionary fiscal policy. The other action taken would be conducting expansionary monetary policy. Both of these actions would have an effect on such things as money supply, interest rates, spending, aggregate demand, GDP, and employment.
Expansionary fiscal policy consists of change in government expenditures, or taxes, in order in influence the level of economic activity, inflation, and economic growth (Amacher & Pate, 2012). Expansionary fiscal policy is when taxes are cut and government spending is increased. Lower taxes will increase disposable income. The increase in disposable income will lead to higher levels of consumer spending. In theory the more money that consumers spend, the higher the chance for economic growth. Tax cuts will also lead to an increase in aggregate demand. Aggregate demand is the total demand for goods and services is the economy. As stated earlier, a tax cut will increase people’s disposable income therefore increasing the amount of money available for consumption. The increase in consumption would increase the demand for goods and services. This in turn increases GDP (gross domestic product). GDP is the value of the total output that the economy produces in a given time period (Amacher & Pate, 2012). The higher the demand that there is for goods and services, the need for employees to produces these goods and services are needed. This increases employment. Lower tax cuts will also increase people’s incentive to work. With lower taxes comes more money to spend from their paychecks.
There are arguments, from economists and politicians, regarding the effect tax cuts in fiscal policy will have on the economy. Some economists argue that the effect of future tax cuts will lead consumers to change their saving (David, 2008).Some economists feel that people will save the value of the tax cut that they receive today in order to pay those future taxes (David, 2008). Some politicians feel that tax cuts will have no effect because changes in private saving will offset changes in government saving.
Tax cuts allow the government to increase spending on special programs and health care. The increased revenue allows a government to borrow less money or lower government debt. This will result in lower interest rates which are beneficial to everyone involved. What is important to look at though is what the increased spending by the government is going towards. Those against increased government spending say that the government spends foolishly. In order to stimulate the economy, the increased government spending needs to go towards those things that are beneficial to its citizens. An example of this would be if the unemployment rate is high and the government spends on hiring workers to fix the roads, this would help to decrease the high unemployment rate. According to a global poll taken in 2009, an average of three in five citizens (60%) supports the increased spending by the government to help stimulate the economy (Global Poll Shows Support for Increased Government Spending and Regulation, 2009). Strongest support is for investments such as renewable energy, green technology, and giving financial support for troubled industries and companies.
Expansionary monetary policy is when a central bank, for example the Federal Reserve Bank (the Fed), uses its tools to stimulate the economy. Often times this means lowering the Fed funds rate in order to increase the money supply. What this does is it increases liquidity which gives the banks more money to lend. The result of this would be lower interest rates. The Fed’s use...
References: (2011). Retrieved April 14, 2013, from frbsf.org:
Amacher, R., & Pate, J. (2012). Principles of Macroeconomics. San Diego: Bridgepoint Education, Inc.
David, W. N. (2008). Fiscal Policy. Retrieved April 14, 2013, from econlib.org: http://www.econlib.org/library/Enc/FiscalPolicy.html
Global Poll Shows Support for Increased Government Spending and Regulation. (2009). PR Newswire .
How the Fed Guides Monetary Policy. (2011). Retrieved April 14, 2013, from frbsf.org: http://www.frbsf.org/publications/federalreserve/fedinbrief/guides.html
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