There are two types of Fiscal policy put in place to alter the level of aggregate demand; Expansionary fiscal policy and Contractionary fiscal policy. When an economy is in a recession, expansionary fiscal policy is in order. Typically this type of fiscal policy results in increased government spending and/ or lower taxes. A recession results in a recessionary gap meaning that aggregate demand is at a level lower than it would be in a full employment situation. In order to close this gap, a government will typically increase their spending which will directly increase the aggregate demand curve (since government spending creates demand for goods and services).
If there is spare capacity (negative output gap), then demand side policies can play a role in increasing economic growth. For example if we decrease interest rates, we will increase the demand in the economy as people have more money as their mortgage costs are decreased. It is the same idea with lowering taxes - this will boost demand, as people have more money to spend as less is taken away from them by the government. Aggregate demand is made up of consumption (consumer spending, Investments Government spending and Exports (minus) imports (Net exports). If anything affects these factors will result in affecting the demand.
Banks have a reserve requirement, which is set by the fed. A reserve requirement is the minimum percentage of a bank’s total reserves that they are required to keep, for security reasons. (Schiller) The fed can change the reserve requirement to allow a bank to loan more/less money, which is used to control the economy. Many critics use this to determine that annual deficit spending has a negative impact on the economic stability of our country. The fed has to set a lower reserve requirement, which allows banks to loan out more money, which generates more interest, which could lead to periods of inflation and could have worse consequences if the government does not react quickly enough.
Ultimately this is used to illicit a raise in GDP levels (Fiscal Policy). 3. An example of this would have been Obama’s Economic stimulus package. This is an expansionary policy as it pulls from money we may not even have as a country in order to avoid a serious collapse due to the population being cautious with their income causing a stall in the economic growth of the country. Therefore, with an economic stimulus package, people were more willing to spend their money (possibly even more than the stimulus was) and take out loans which all raise the GDP for the country as well as improve investor confidence in the market as a whole (Eaton, G.).
When the demand for U.S. dollars increases, the value of the dollar will increase or appreciate (Stone 2008, pp. 685). As a result, U.S. products become more expensive for foriegners causing a reduction in exports and increasing imports. This not only effects the U.S. economy, but also affects the economies in other countries. Monetary policies influence and are influenced by international developments, including exchange rates, and based on these market conditions the U.S. government can make strategic changes to these policies to maintain the country’s economic stability (full employment, stable growth and price stability).
For example, if interest rates increase, the income of homeowners who have variable-rate mortgages will fall – leading to a decline in their effective purchasing power. The effects of a rate change are greater when the level of existing mortgage debt is high, leading to a rise in debt-servicing burdens for home-owners. On the other hand, a rise in interest rates boosts the disposable income of people who have paid off their mortgage and who have positive net savings in bank and building society accounts. Consumer demand for credit would also increase Aggregate Demand, as higher interest rates increase the cost of servicing debt on credit cards and should lead to a deceleration in the growth of retail sales and
An essay on Keynesian Vs. Classical: An Economic Perspective to Rekindle the US Economy By P. V. Manohar Kiran Discussing Ø Which of the two major approaches to Economic policy (Keynesian or Classical) will lead the USA out of the economic crisis faster? Ø What are two differences between those two types of economic policies? Why this comparison The year 2008 saw the worst financial crisis in modern times, triggered by a highly unbalanced and overleveraged economic debacle in USA, which caused a ripple effect throughout the global economy, thereby dragging down even healthier and safer countries (economically) with itself. An instant analogy to the Great Depression of the 1930 was drawn, and till date arguments ensue upon the issues which caused both of these debacles respectively.
This is unlikely to be the case in the UK at the moment as low interest rates and a large budget deficit has not cause significant inflation. A further conflict with loose demand side policies might the effect on the current account. With higher economic growth and consumption, we might expect an increase in the demand for imports and a worsening of the current account. This is likely to be a fairly significant effect for the UK because it has a high marginal propensity to import – especially for manufactured goods. Furthermore, if there is inflation from the demand side policies then there will be a fall in UK competitiveness and a
Freidman argued that there was a natural rate of unemployment and that attempts to reduce unemployment lead to other problems like inflation. Neoliberals thought that inflation undermines the market system because there is lack in faith of money and discourage money economic activity. In order to solve inflation the government needed to control growth in money supplies by cutting public spending and allowing unemployment to rise so the market can solve the problem. The liberal new right regards the state as a realm of coercion and “unfreedom”,
Government spending consists of salaries for government employees, defense spending, aid programs, and other cash outflows. Government revenue primarily consists of taxes. When the government spends more than they receive in the form of revenue, a budget deficit occurs. The causes and the implications for long-term economic growth due to a high budget deficit on the economy, along with the role that fiscal and monetary policy plays, will be defined and explained. The development of a increasing budget deficit has been caused by a weak economy and the result of increased government spending in areas such as health care, education, defense spending, low interest rates, lowering taxes, and the increase in welfare and entitlement programs.