In chapter 16 we learned about fiscal policy –the federal government’s tool kit

Question

In chapter 16 we learned about fiscal policy –the federal government’s tool kit for addressing business cycle fluctuations. In chapter 12 we learned that business cycle fluctuations are caused by changes in aggregate expenditure. One implication of this idea is that if we are in a recession, it is because total spending has decreased. Therefore, if we want to get out of a recession, total spending needs to increase. Chapter 16 offers two ways to stimulate total spending –through tax cuts or increases in government spending.

Typically, Republicans favor tax cuts, while democrats favor increases in government spending. There are economic rationales for both positions. Tax cuts put money into the pockets of consumers, who are better than the government at determining how resources should be allocated –this promotes “allocative efficiency” (from chapter 1). On the other hand, the tax multiplier is smaller than the government purchases multiplier (see section 16.4 in the text). This means that we get more economic stimulus from a given dollar value of government spending than the same dollar value in tax cuts.

The tradeoff here is between more efficiency (with tax cuts) vs. more economic stimulus (with government spending). Differences of opinion on this matter are cause for heated political debate and overblown political rhetoric.

So what do you think? Do you prefer economic stimulus from tax cuts or increases in government expenditure?

Explanation / Answer

In my views, I will adopt a judicious combination of “tax cut” stimulus as well as “government spending” policy.
The above view is based upon following rationale:
1.   Tax cut simply improve the disposable income of the consumers and demand is increased that stimulate the economy. But, control on MPC and MPS is totally in the hands of consumers. Thus, total dependence on this stimulus may not give the desired results.
2.   Government spending causes to increase the demand. To cater this demand, firms start producing and employment is created. Increased employment increase the disposable income. Thus, demand increases. Here, control lies with the government.
If government spending strategy is clubbed together with tax cut, then disposable income becomes bigger. It has a positive effect in a further surge of demand. Also, tax cut improves the consumer confidence in the economy.   Thus, a combination thereof is more stable in nature where optimum growth can be achieved.

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