Whenever the U.S. enters a recession there are usually calls for politicians to

Question

Whenever the U.S. enters a recession there are usually calls for politicians to enact policies that will stimulate the economy.Please answer the following questions related to fiscal policy: What are the tools of expansionary fiscal policy? In other words, what options do politicians have? What are the long-term implications of expansionary fiscal policy? How would a balanced budget amendment impact the use of fiscal policy? The federal government debt level? Based on this information, would you support a balanced budget amendment? Why or why not?

Explanation / Answer

Fiscal policy can be used as one of the ways to drive the economy out of recession. The tools under FP are

1) Increase in govt expenditure- this raises aggregate demand and stimulates production. with multiplier affect in action, it can lead to higher growth eventually.

2). Decrease in tax rates- this increases the disposable income and lead to higher pvt consumption. this again stimulates economy by multiplier affect. Decrease in corporate tax is another way to increase production and emloyment levels.

Long term impacts

1). Higher Fiscal deficit due to more expenditure than income of the govt. in long run can lead to high debt levels and interest liabilities on the country.

2). Higher inflation is possible because rise in demand is not always accompanied with rise in supply. so the FP used to increase demand end up increasing price levels.

3). crowding out of pvt investment- this is so because govt borrows to pay for the expansionary FP leading to higher interest rates. This leads to costlier loans to pvt now , so we see a decline in pvt investment.

4). Positive impacts could be: more public goods, better infrastructure etc.

Balanced budget amendment is a rule whereby the govt expenditure cant exceed its income levels. This rule would obviously impact the use of FP as now the govt would be restricted to spend beyond a limit. But it would be a safer option as well because debt levels will stay under control for sure. However, expansionary policies are sometimes very necessary to stimulate the economy. for eg., in 2008 crisis, govt kept up the levls of govt expenditure both to provide the necessities to the people and to boost the demand. Therefpore, it is important that there should be some exceptions allowed in the balanced budget rule to address some specific scenarios.

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