Current Topics in Macroeconomics: Questions for Debate
Read each of the four webpages linked from this section: "Arguments For and Against Discretionary Monetary Policy," "Arguments For and Against Fighting Recession with Expansionary Monetary Policy," "Arguments For and Against Fighting Recession with Expansionary Fiscal Policy," and "Arguments For and Against Inflation Targeting Policy Interventions". You will gain additional insights about policy formation, implementation, and evaluation. In each case, consider whether the right questions were asked and whether the proper measures received focus. Which side of each of these debates would you find yourself?
Arguments For and Against Fighting Recession with Expansionary Fiscal Policy
Expansionary fiscal policy, usually implemented during recessions, refers to policies aimed at increasing demand and thus output.
LEARNING OBJECTIVE
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Understand the pros and cons of fiscal policy intervention during recession
KEY POINTS
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The two main instruments of fiscal policy are changes in the level and composition of taxation, and government spending in various sectors.
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Fiscal stimulus through the debt creation channel, may result in reducing the availability of loanable funds, increasing interest rate which may in turn cause a lower aggregate demand for goods and services, contrary to the objective of a fiscal stimulus.
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Fiscal stimulus is implemented with the view that tax relief through a reduction in tax rate and or direct government spending through investment will provide stimulus to increase economic growth by directly influencing consumption or the government expenditure component of GDP.
TERMS
- fiscal stimulus
Involves government spending exceeding tax revenue, and is usually undertaken during recessions.
- crowding out
A drop in private investment caused by increase in government investment.
Fiscal policy is the use of government revenue collection (taxation) and expenditure (spending) to influence the economy. The two main instruments of fiscal policy are changes in the level and composition of taxation, and government spending in various sectors.
Expansionary fiscal policy, usually implemented during recessions, refers to policies aimed at increasing demand and thus output. This is done by expanding or increasing government expenditure, reducing taxes, or both.
Remember that government revenue is based on collected taxes. When taxes exceed government spending, the government is characterized as having a "surplus". When taxes equal government expenditures, the government has a balanced budget. When the government spends more than the revenue it collects, it has a deficit. Increasing government spending, creating a budget deficit, and financing the shortfall through debt issuance are typical policy actions in an expansionary fiscal policy scenario.
Due to the funding process of expansionary policy, there is a lack of consensus among economists with respect to the merits of fiscal stimulus. The discord mostly centers on crowding out, defined as government borrowing leading to higher interest rates that in turn may offset the stimulative impact of government spending. When the government runs a budget deficit, funds will need to come from public or foreign borrowing, as a result, the government issues bonds. The issuance of government bonds, may result in an increase in interest rates across the market, because government borrowing creates higher demand for credit in the financial markets. This may in turn cause a lower aggregate demand for goods and services, contrary to the objective of a fiscal stimulus.
Fiscal stimulus is implemented with the view that tax relief through a reduction in tax rate and or direct government spending through investment (infrastructure, repair, construction) will provide stimulus to increase economic growth by directly influencing consumption or the government expenditure component of GDP.
Fiscal policy: Taxes