Fiscal_Policy

1. Pro-Fiscal Stimulus – expansionary fiscal policy is beneficial because: • Increased government expenditures and/or reduced taxes will stimulate aggregate demand and boost incomes as it will increase confidence of consumers and investors. • That will lead to an increase in output followed by an increase in national income and reduced unemployment. • Resulting economic growth will have a healing effect on economies experiencing recession and will lead to a decrease in national debt levels. • Currently being undertaken by the US government with measures aimed at preventing sharp declines in demand in the short run and adding confidence by controlling factors that increase budget deficits. 2. Anti-Fiscal Stimulus – Governments should tighten their budget because: • Future Indebtedness: Stimulus measures increase Government borrowing and budget deficits. • Investment Credibility: Large deficits threaten long-term fiscal credibility. • Consumer spending will not increase: consumers anticipate that the government will implement tax increases to pay off public debt in the future and therefore save money instead of spending it. • Crowding out if investment: If the private sector lends money to government they will not have these funds to invest. • Output or unemployment is not stimulated: increased government borrowing will increase interest rate, thus, reduce investment and net exports. Therefore, the deficit caused by fiscal stimulus may limit increases in output and employment. 3. Do you think the debate is entirely “objective” in an economic sense; if not, why not' The debate is not “objective” as each side’s argument rests upon their fundamental economic beliefs. For example, neo-classical economists and Keynesians believe that fiscal measures introduced by the government will stimulate demand and a multiplier effect will boost the overall economy by more than the initial stimulus, thereby spending will actually reduce a budget deficit. Ben Bernanke, Chairman of the Federal Reserve, devoted much of his academic life to studying the great depression, where a lack of government support contributed to the downward spiral of the US economy, and hence will likely favour any pro-stimulus argument. Monetarist economic theory states that controlling the money supply and maintaining price stability is key and hence would be unlikely to support stimulus measures which could ultimately lead to inflation. Other schools of thought, such as ‘supply side’ and ‘Austrians’, will have counter views as to the optimal focus and level of government intervention. 4. Is this debate one that can be answered by reference to economic/fiscal data & the models that are produced from them' Whilst arguments can be constructed using various forms of economic data and models we cannot produce a definitive answer. Economic models require assumptions which are often unrealistic and therefore impractical for use in policy making decisions. Data, which may prove difficult to collect accurately, can be affected by a large number of variables. Moreover, economic/fiscal data and models that are produced from such data may change considerably over time. Currently, it seems that existing models are incapable of capturing behavioural finance and human psychology factors which determine economic performance. 5. Where does this leave (G20) policymakers' ; More stimulus or rapid fiscal consolidation' The G20 was established in 1999, in the wake of the 1997 Asian Financial Crisis, to bring together major advanced and emerging economies to stabilize the global financial market. In 2009 when the G20 group met in London, in the midst of global recession, the group unanimously agreed to support a fiscal stimulus package to the tune of more than a trillion dollars, financed chiefly by European Central Bank (ECB) and IMF. This was Keynesian style demand management in the face of soaring unemployment and collapsing economic activity. At the 2010 summit the idea of fiscal stimulus was dropped in favour of internal debt management. Christine Lagarde, French foreign minister said: “There’s a large majority for whom redressing the public finances is priority number one. For a minority it’s supporting growth.” Tim Geithner, US treasury secretary is concerned that this policy adjustment could threaten the momentum of recovery. It may be that the G20 has reached a point where it can no longer use ‘one size fits all’ agreements with different members requiring different fiscal policies to suit their current status. Brewing currency wars and potential retaliation may be a sign that co-ordinated economic policies are no longer feasible.