You are in charge of the economy of a small country undergoing an economic downt

Question

You are in charge of the economy of a small country undergoing an economic downturn. Your only choices to impact the economy are to change the tax rate or change the money supply (in this you can print more money, change interest rates, change the reserve requirement, or purchase or sell bonds). In what way would you change the tax rate (if any) and in what way would you change the money supply (if any)? Please explain what you intend to do or not to do and why if the economic downturn is mild, if the economic downturn is moderate, and if the economic downturn is severe? Please make sure your answers are consistent with current economic theory.

Explanation / Answer

When the economy is in the downturn, counter cyclical measures need to be taken to take the economy towards growth path. According to the Keynisian economic model stimulus need to be provided for the economy by the government in the form of quantitative easing, reducing tax rate, cutting the bank rate . Increasing the public spending etc..

Let us consider various cases given in the Question.

Economic Downturn is Mild :

The GDP growth rate will be downward and the unemloyment rate starts increasing. In this case the Governement can reduce the tax rates for the corporations and inidvidual. So more private spending and consumption will increase the economy. The exchange rate can be made favourable for the exports by open market operations. Governmnet can sell the bonds at high premium so that the money supply in the economy increases.

Economic downturn is Moderate:

The GDP would be falling moderately and unemployment rate and exports will see downward spiral. In this case the policy makers should be cautious to reduce the further impact. Government need to resort to series of measures like further reducing the tax cuts, providing incentives for increase of production. Reducing the interest rates by the central banks , providing more capital to the industry. Government can start spending more in infrastructure project to create employment and increase public consumption.

Economic downturn is severe:

This is the case of recession and depression tendencies, the Government has greater role to play . Bailing out the campanies which have bankrupted, quanititative easing mechanisms, reducing the tax rates and interest rates, promoting the production by incentivising companies. Increasing Public spending so as to create more employment, spending more on infrastructure projects. etcc are the steps to be taken.

Dear student , you can add few more measure in the broad frame work given.

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