Term Paper
Economics – 6644-01
Paper Topic: Fiscal Policy
Introduction
There is an ongoing debate about implications of government fiscal policies on economic
growth, particularly in emerging countries. One school of view contends that the spending cuts
are justifiable due to the high welfare cost of taxes as well as the low productivity and
ineffectiveness of government spending. The provision of public goods, the encouragement of
productive investment, and the creation of a socially optimal path for economic progress are all
views that the government plays a crucial role in economic development.
Three broad methodologies have been used to assess the influence of government fiscal policies
on economic development. The first approach is to simply take into account regressions of
growth rates on median government expenditures or tax rates. The second strategy focuses on the
effectiveness of public spending and fundamental production non-cavities. The third choice is to
relax the equilibrium assumption and let nations embark on a transitional route where the
proportion of taxes and spending on the government changes over time. (Kuligowski,2022)
What is Fiscal Policy?
Fiscal coverage is the usage of authorities spending and taxes to steer the economy. Central
governments frequently use financial regulations to sell sturdy and sustainable boom and
decrease poverty. The position and goal of financial coverage got here to prominence for the
duration of the latest worldwide monetary disaster, while governments intervened to assist
economic systems, repair boom, and mitigate the effect of the disaster for prone groups. Before
1930, the significance of financial coverage became constrained and research affirm that the
technique of confined authorities, or laissez-faire management prevailed. Events like stock
markets’ crash, pandemics and the Great Depression, policymakers drive for governments to
play an extra proactive element inside the economies. (Horton & El-Ganainy, 2020)
Fiscal policies are closely inspired through the theories of British economist John Maynard
Keynes. Rather than permitting markets to accurate themselves, Keynes claimed that
governments would possibly stabilize the enterprise cycle and adjust financial activity. A
financial coverage this is expansionary reduces tax costs or boosts spending that allows you to
boom mixture call for and power financial growth. Contractionary financial coverage boosts
hobby costs or reduces spending that allows you to save you or decrease inflation. Economic
achievement is regularly assessed through some factors, along with GDP. Another issue is
mixture call for, that's the sum of a country's services and products bought at a particular fee
point. The mixture call for curve states that at decrease fee points, extra items and offerings are
demanded, at the same time as at better fee levels, much less call for exists. Fiscal policies have
an effect on those indicators, with the aim of growing GDP and mixture call for in a sustainable
manner. Taxation of businesses: Profits and funding are encouraged with the aid of using the
taxes that corporations pay to the government. Tax cuts raise mixture call for and organization
funding spending. Government expenditure: government's spending raises aggregate demand.
Individual taxes: Taxes levied on individuals, along with earnings tax which influences their
non-public earnings and remaining cash left for them to spend which injects extra money again
into the economy.
How does Fiscal Policy Work?
When policymakers search for approaches to effect the economic system, they have got essential
gadgets at their disposal —financial policies and monetary policies. Central banks in a
roundabout manner target movement with the aid of using impacting the money supply via
changes to intrigued rates, financial institution keep prerequisites, and the purchases and sale of
presidency securities and overseas exchange. Governments bring the impact in the economic
system with the aid of using converting the extent and styles of taxes, the diploma and
composition of investing, and the degree and form of borrowing.(Horton & El-Ganainy, 2020)
Besides offering items and offerings which can be crucial for public safety, highways, and
primary education, monetary coverage goals can vary. In the fast term, governments ought to
attention on macroeconomic stabilization – for example, growing spending or decreasing taxes to
reinforce a suffering economic system, or reducing spending or growing taxes to combat
growing inflation or lessen outside vulnerabilities. In the longer term, the intention can be to sell
sustainable increase or lessen poverty via deliver-aspect measures to enhance infrastructure or
education. Although those desires are extensively shared with the aid of using countries, their
relative significance varies relying at the United States of America’s circumstances. In the fast
term, priorities may also replicate the enterprise cycle or the reaction to a herbal catastrophe or
an boom in worldwide meals or gasoline prices. In the lengthy run, the using issue can be
improvement level, demographics or herbal aid endowment. Fiscal coverage includes using the
government’s finances to perform the respective United States of America’s financial goals.
Each United States of America attempts to make use of monetary coverage on the satisfactory to
put into effect vital modifications within the financial pastime of the nation, utilization of
resources, the distribution of profits degrees and outside stability. Besides the person
contraptions of spending and sales collection, the Budget produces an general final results which
offers an illustration of the general effect of monetary coverage at the kingdom of the economic
system.
There are three possible budget outcomes.
1. Fiscal surplus (when estimated revenue exceeds estimated expenditure)
2. Fiscal deficit (when estimated government spending exceeds estimated expenditure)
3. Fiscal balance ( when estimated government revenue equals estimated expenditure).
The budgetary outcome is considered one of the most accurate indicators of fiscal policy
because it removes the influence of one-off factors (such as asset sales or government
debt repayment).
Objectives of Fiscal Policy
1. Full employment: The first and primary goal in a growing financial system is to reap
and keep complete employment. Even if complete employment isn't accomplished in
those countries, the principle aim of the authorities is to keep away from unemployment
and reap close to complete employment. Therefore, to put off unemployment and
underemployment, the authorities ought to spend sufficient to cowl the financial and
social costs. This spending will assist create greater jobs and increase the efficient
performance of the financial system.
2. Price stability: Government ought to attempt to take away bottlenecks and structural
tension that purpose imbalances in one of a kind sectors of the financial system. In
addition, it ought to fortify bodily controls over critical products, permits, subsidies and
protections within side the financial system. In short, fiscal measures should contribute to
achieving the goals of economic growth and stability.
3. Economic stability: Fiscal policy in a developing economy should aim to promote
economic growth. But high economic growth cannot be achieved and sustained without
economic stability. Hence, fiscal measures like taxes, government borrowing and deficit
financing, etc. must be used properly so that production, consumption and distribution
have no negative effects. It will stimulate the economy as a whole, thereby helping to
increase national income and per capita income.
4. Reduce Inequality: To reduce inequality and distribute it fairly, governments should
invest in productive value chains that benefit low-income groups and help increase their
productivity and technology. Therefore, redistributive spending must help economic
development, and economic development must help redistribution. Thus, a well-planned
fiscal program, public expenditures can contribute to the development of human capital,
which in turn has a positive impact on the distribution of income. Regional disparities can
also be eliminated by providing incentives for lagging regions. The redistribution tax
policy should be highly progressive and aim to levy taxes on the richer sections and
exempt the poorer sections of the community from taxes. Similarly, luxury goods,
consumed by the upper classes, can be heavily taxed.
5. Equal distribution of income : The importance of equal and fair distribution of income
and wealth in a developing economy needs not be stressed. In general, wealth inequality
persists in these countries because, in the early stages of growth, it is concentrated in a
few. It is also because private ownership dominates the entire structure of the economy.
In addition, extreme inequality creates political and social discontent, giving rise to
further economic instability. Thus, an appropriate government fiscal policy can be
designed to close the income gap between different sections of society.
6. Capital Formation and Growth: Capital is on the coronary heart of all improvement
pastime in a rustic, and financial coverage may be used to sell the quality ability price of
capital formation. A 'vicious circle of poverty' surrounds a freshly developing economy.
To smash the vicious circle, balanced boom is required, that is simplest viable with a
better price of capital formation. When a rustic emerges from the clutches of
backwardness, it stimulates funding and capital formation. (Deepa, 2015)
A. Raising the ratio of financial savings to Income with the aid of using controlling
consumption.
B. Raising the price of funding.
C. Encouraging the glide of spending into efficient way
D. Reducing the growing inequalities of earnings and wealth.
How can the government manage the economy with an effective fiscal policy?
Government can alter tax policies to stabilize the business cycle and economic output.
Government spending can be increased in response to a decline in private sector spending in
order to directly boost aggregate demand. Government can invest in developing infrastructure
and railroads, among other things. Government can work to encourage growth when the
economy is slowing down, and to reduce inflation when the economy is soaring. The fiscal
strategy facilitates resource mobilization for project financing. The goal of fiscal policy is to
reduce/decrease the income and wealth inequalities. All working individuals are subject to
income tax in proportion to their income. Few extra taxes are likely to be higher on luxury and
semi-luxury products than on consumer staples. In this way, the government gets a lot of money,
which also helps to reduce the gap between the rich and the poor. Most people agree that
government intervention is necessary to maintain a thriving economy, which is essential to the
economic well-being of its people.
The Great Recession
The Great Recession was a significant drop in economic activity in the late 2000s. It is generally
recognized as the largest decline since the Great Depression. A Great Recession is a general
period of significant recession, i.e., the recession experienced by the world economy from 2007
to 2009. The term "Great Recession" refers to the official recession in the country. The United
States from December 2007 to June 2009 and the subsequent global recession in 2009. The
economic conflict began as the US housing market went from boom to bust, resulting in massive
losses. from asset-backed securities to mortgage loans (MBS) and derivative products. The
severity and duration of the recession varies from country to country. Low mortgage rates, easy
lending, less regulation, and risky subprime mortgages all played a role in the crisis. The
International Monetary Fund (IMF) at the time said it was the worst economic and financial
crisis since the Great Depression. As a result, normal international ties were severely disrupted.
Origin
In an attempt to preserve financial balance within side the face of the 2001 Internet increase and
next recession, in addition to the September 11, 2001 assault at the World Trade Centre, the USA
Federal Reserve hobby charges fell to the bottom stages located within side the post-struggle fare
period. Bretton Woods Era. The Fed saved hobby charges low till mid-2004. These low hobby
charges, mixed with federal rules that endorsed homeownership, contributed to a speedy increase
within side the housing and monetary markets in addition to notably growing loan debt overall.
Financial improvements which includes new subprime mortgages and adjustable mortgages
permit in any other case unqualified debtors to acquire beneficent domestic loans primarily based
totally at the concept that interest charges will stay low and domestic values will rise. However,
the Federal Reserve progressively multiplied interest charges from 2004 to 2006 to hold inflation
consistent within side the economy. The float of recent actual property loans via conventional
banking channels has bogged down because of growing marketplace hobby charges. Interest
charges on present regulated mortgages and extra overseas loans are returning to a whole lot
better stages than maximum debtors or incentives expected. It may be extra serious. The end
result became what became sooner or later diagnosed through many as an actual property bubble.
(Brian Dugnan, 2012)
During the real estate boom of the mid-2000s in the United States, financial institutions began
offering complex derivatives and mortgage-backed securities at unprecedented interest rates.
During the real estate market crash of 2007, this property suffered a sharp drop in value. When
the financial crisis began in 2007, the credit markets inflated the housing bubble. quickly led to a
decrease in property prices. With the collapse of Bear Stearns in March 2008, the solvency of
banks and financial institutions reached breaking point. This recession was further complicated
by the September 2008 bankruptcy of Lehman Brothers, the country's fourth-largest investment
bank. Other economies around the world, especially in Europe, were quickly affected.
(Brian Duignan, 2012)
Causes of the Great Recession
Many factors, immediately and indirectly, contributed to the Great Recession, which started in
2008 with the subprime loan disaster within side the United States. The fundamental reasons of
the preliminary subprime loan disaster and next recession had been lax lending standards, which
contributed to the housing increase that followed, the United States authorities's housing policy,
and the insufficient supervision of unsupervised economic institutions. When the recession hit,
many responses had been attempted, with various ranges of success. These regulations
encompass authorities economic regulations, critical financial institution economic regulations,
measures to assist indebted clients refinance their loan debt, and inconsistent strategies.
Consistency is utilized by nations to bail out chaotic banking industries and personal
bondholders, assuming personal debt burdens or socializing losses. Some economic companies
have taken on immoderate risk. Shadow banking has advanced to compete with normal banking,
however isn't concern to the identical scrutiny or regulation. When the shadow financial
institution collapsed, the glide of credit score to clients and groups turned into disrupted. Other
reasons encompass immoderate purchaser and enterprise borrowing, in addition to policymakers'
lack of ability to absolutely apprehend a failing economic system. This caused assets bubbles,
mainly within side the housing market, as low-hobby mortgages had been issued to debtors who
had been ineligible and not able to repay. As a result, housing costs have plummeted, leaving
many house owners below water. This has a enormous effect available in the marketplace for
loan-subsidized securities held with the aid of using banks and different institutional investors.
Effects
Many of these companies appealed for government bailouts, sought mergers with larger firms, or
filed for bankruptcy when the portfolios of even famous banks and investment firms were found
to be mostly fictional, based on essentially worthless ("toxic") assets. Other important companies
that marketed their goods frequently through consumer loans also experienced sizable losses.
General Motors and Chrysler, two automakers, for instance, filed for bankruptcy in 2009 and
were compelled to accept some government ownership as a result of bailout plans. Consumer
confidence in the economy suffered during this period. As a result, most Americans cut down on
their spending in expectation of future tougher times, a trend that delivered another blow to the
health of businesses.
Over the past ten years, poverty in the suburbs has soared by more than a third. Although inner
city poverty rates are still greater, the difference is getting smaller. Earlier recessions mostly
spared suburban areas, but not this one. From 2005 to 2007, the personal savings rate was less
than 3% of disposable income; in 2010, it was approximately 6% of disposable income.
Additionally, the overall quantity of outstanding consumer credit has decreased with the current
recession for the first time since 1940. Family members are likely to experience broad and
significant effects. The recession's most overt effects are layoffs and unemployment, which are
also known to be associated with greater stress levels, poorer health outcomes, declines in
children's both academic and non-academic achievements, postponement/delays in marriages,
and changes to family structures. There was a 12% increase in multigenerational homes between
2006 and 2010, according to recent data. State budget shortfalls total roughly $300 billion
between 2009 and 2012 as a result of declining revenue and rising demand for state services. 35
states reduced their K–12 and higher education budgets by a combined $8 billion in 2010, and 31
states plan to further reduce their education budgets in 2011. Home foreclosure filings grew from
around 1.2 million per year to almost 4 million between 2006 and 2009, and they were
disproportionately located in black and Hispanic communities. This kind of concentrated loss of
homes portends more social unrest and the possibility of deterioration. Being a homeowner is
also one of the main ways Americans accumulate wealth, which suggests more financial turmoil
for millions of Americans both now and in the future. As the recession took hold, the number of
economic migrants crossing the border from Mexico to the United States drastically decreased.
Internal migration patterns also have changed as a result of the drop in traditional work prospects
for migrants. About four million more individuals were living in poverty in 2009 than in 2008,
which resulted in an increase in the poverty rate from 13.2% to 14.3%. Since 1969, there have
been almost constant large rises in poverty rates, with children being disproportionately affected.
The efficiency of the U.S. labor market, as well as the lives of the jobless, their families,
communities, and the organizations that help them, are likely to be significantly impacted by an
extended period of high unemployment characterized by historically high rates of long-term
unemployment. The Great Recession has made American politics particularly erratic, with
increased popular resentment toward incumbents blamed for the crisis, massive electoral swings,
and new approaches of political finance and organization. State and municipal pension shortfalls
are anticipated to be close to $4 trillion, while private pension balances are still down from prerecession levels despite the rebound of the stock market. Out of the 14.6 million unemployed
people, roughly 46% had been out of work for 27 weeks or more, and about 31% had been out of
work for 52 weeks or more. (Russel sage Foundation, 2012)
Steps taken to address the Great Recession
The Dodd-Frank Act of 2010 additionally brought new policies for the way massive economic
businesses are handled. As an illustration, the Financial Stability Oversight Council is capable of
designate non-conventional credit score intermediaries as "Systemically Important Financial
Institutions" (SIFIs), setting them below the Federal Reserve's supervision. The regulation
additionally set up the Orderly Liquidation Authority (OLA), which allows the Federal Deposit
Insurance Corporation to shut down positive banks wherein the failure of the organization might
be fairly unstable for the economic system. Large economic establishments also are required
with the aid of using some other provision of the regulation to develop "residing wills," which
might be complete plans outlining how the group might be dissolved according with US financial
ruin regulation without endangering the relaxation of the economic region or requiring
authorities assistance.
Steps taken to handle the recession:
American Recovery and Reinvestment Act: On February 17, 2009, President Barack Obama
signed the American Recovery and Reinvestment Act of 2009, which acted as a financial
stimulus. In the years that followed, it raised unemployment, which aided in ending the 2008
crisis. It mainly limited government spending, tax breaks, and loan guarantees to revive the
faltering economy. It promoted small businesses, financial aid for families, renewable energy
sources, healthcare, education, and infrastructure. It also funded scientific research and
development. (Amadeo, 2021)
It mainly consisted of seven Elements: Immediate relief for families- By giving families 260 billion dollars, the ARRA raised demand.
They received the funding in the form of tax credits, tax rebates, and unemployment benefits.
The majority of the cash was distributed within the first two years. Modernized federal
infrastructure- AARA created jobs by facilitating shovel-ready public works projects. This was
the most cost-effective way of job generation. The Umass/Amberst analysis found that 19,795
jobs were created for every billion dollars spent on public works. (Amadeo, 2021)
Increase Alternative energy production- The investment gave alternative energy a very big boost
in the United States.
Expended Healthcare- The higher healthcare expenditures brought on by the 2008 recession were
financed by this. By computerizing the medical records, it facilitated the transmission of patient
medical information among clinicians.
Improved Education- Spending millions of dollars on education was the best course of action.
According to the Umass study, $1 billion in federal spending resulted in the creation of 17687
jobs. Invested in Science Research and Technology- Furthermore, investment for rural internet
connectivity created the necessary conditions for the computerization of medical records needed
to expand healthcare. Helped the Small Businesses- 70% of all new jobs are created by small
businesses. For tax benefits, credits, and loan guarantees for small businesses, the ARRA
provided $730 million. Four months after the AARA was passed, the recession came to an end.
In the first 18 months, the economy added 1.7 million government jobs and 2.4 million jobs in
the private sector. AARA had something for everybody. (Amadeo, 2021)
Troubled Assets Relief Program: Troubled Assets Relief Program also known as “Bank
Bailout” was an economic program signed by President George w Bush on Oct 3, 2008. The
Treasury Department was able to pump money into failing banks and other businesses through
the TARP program by purchasing their stock and assets. The main objectives of this program
were to strengthen the auto industry, balance the markets, and lower consumer debt. TARP was
initially established to aid banks, but it later expanded to assist the insurance, finance, housing,
and automated industries. (History.com, 2012)
The Capital Purchase Program (BANKS): Under the capital purchase program the USA
government purchased stocks of the bank and against that the banks were required to pay a 5%
dividend to the government which will go to 9% in five years. The increasing dividend
encouraged the banks to buy back their stock in five years. In this way the banks got five years to
recover, and the government made profit as the economy began to grow again.
American International Group (INSURANCE): The government prevented the massive
insurance company American International Group from going bankrupt using this program.
CREDIT AND HOUSING
Credit and Housing: In accordance with this scheme, the government provided loans to its
affiliate banks to enable them to continue providing credit to consumers and companies.
Additionally, it developed a program called Home Affordable Modification that encouraged
banks to reduce monthly mortgage payments for borrowers who faced impending foreclosure.
Homeowners, service providers, and investors benefited from this scheme.
The Automotive Industry: President Bush provided funding to the top three automakers
through this initiative. By paying an 80.7 billion bailout, the government prevented General
Motors and Chrysler LLC from going bankrupt.
The major goal of the TARP was to quell the market's financial panic brought on by reports that
massive corporations like Lehman Brothers, AIG, Freddie Mac, and Bear Streams were on the
verge of collapse. With this plan, the government not only secured these businesses but also
saved the way of life for millions of individuals who had been rendered jobless. TARP prevented
the country's banking system and economy from collapsing. (History.com, 2012)
How India handled Great Recession
India exhibited more resistance to the global financial crisis that began in the USA in 2007. The
USA, UK, Japan, China, France, and India were just a few of the nations whose economies were
affected by this financial crisis. Different nations experienced this instability in different ways.
India felt less of the global gloom. For a variety of reasons, the world has been encouraged to
believe that India has escaped the current global crisis. This viewpoint was significantly
influenced by the financial policies that were put in place in India after liberalization in 1991.
Financial regulators including the RBI, SEBI, the Ministry of Finance, and the Ministry of
Corporate Affairs actively participate in the heavily regulated market in India. These authorities
make sure that even if Indian markets are open to foreign competitors, they are also less exposed
to global mishaps. Important step taken by the Government of India (GOI) to regulate foreign
institutional investment is Participatory Notes (P Notes) (FII). P Notes are the key to determining
whether foreign investors withdrew from stock markets during recessions. (Kibe, 2012)
In 1969, some of the Indian banks were nationalized, which made it easier for the government of
India to impose policies including a high Cash to Reserve Ratio (CRR), a strict credit policy, and
lending rate regulation. As the recession in the United States began as a result of the fall of the
subprime bubble, financial institutions began lending to borrowers with worse creditworthiness
at higher rates in an effort to boost their profits. This control over banks has shown to be
beneficial for India. Above rules in India kept Indian Banks from slipping into this trap.
Interest rates in India were reduced from 7% to 3.25%. By the end of 2008, the yield on India's
10-year government bonds had fallen from 9% to 5%. The government let the fiscal deficit rise
from 2.5% of GDP in fiscal year 2008 to 6% in fiscal year 2009 and 6.5 in fiscal year 2010,
respectively. Three stimulus measures totaling $40 billion, or 3.5% of the GDP, were introduced
by India. (Narayan, 2018)
How China handled the Great Recession
In late 2008, China unveiled the largest stimulus program in history, totaling $584 billion for
infrastructure and social welfare initiatives. The one-year lending rate was lowered by China's
state-owned bank from 7.5% to 5.5%. China's state-owned banks acted as an economy's
"automatic stabilizer." China has a market authoritarian economic system that gives the
government greater exact control over all economic activity there.
China introduced monetary policies that were accommodating and energizing. given tax
reductions and rebates. bailed out numerous state-owned businesses and put in place a thorough
stimulus plan. In 2010, the Chinese economy expanded and recovered from its 2009 low of
8.7%. When other nations saw zero or negative growth between 2007 and 2013, China's total
industrial production nearly doubled. China surpassed Germany and Japan to become the second
largest economy in the world.
Implications for operating in a Global Economy
The use of taxation and expenditure with the aid of using the authorities to have an effect on the
economic system is called monetary coverage. Fiscal coverage is the system thru which the
authorities determines what commodities and offerings to buy, the way to distribute switch
payments, and what kind of sales to collect. Any adjustment to the federal price range has a
disproportionately terrible financial effect on a few demographic groups; for example, a tax
lower for households with youngsters will increase their discretionary income. However,
discussions of monetary coverage usually middle on how modifications to the federal price range
could have an effect on the nation's economic system as a whole. The term "monetary coverage"
is usually used to consult the effect on the general economic system of the stages of spending
and taxation, and extra specifically, the distinction among them. Although modifications in taxes
or spending that are "sales neutral" can be construed as monetary coverage—and might have an
effect on the mixture degree of output with the aid of using converting the incentives that
companies or people face—and might extrude the incentives that companies or people face aren't
continually taken into consideration to be monetary coverage. When sales exceeds spending (i.e.,
the authorities price range is in surplus), monetary coverage is taken into consideration to be
tight or contractionary. Conversely, whilst spending exceeds sales, it's far stated to be free or
expansionary (i.e., the price range is in deficit). The motive of monetary stimulus is to enhance
the economic system's standard call for. Fiscal stimulus can purpose an unsustainably excessive
call for items and offerings that the economic system is not able to deliver if it's far completed
too aggressively or whilst it's far already running near complete capacity. Inflation is the
phenomenon of fees growing whilst there's an opening among deliver and call for items and
offerings.
To create the conditions for semi-permanent economic health, we have a tendency to should
initial establish actuality structural downside that has led to the present predicament. the
elemental issue was that, following the 1980s, the "Great Moderation" of volatility in industrial
countries enabled circumstances for finance to urge larger relative to GDP and credit to extend
chop-chop in every boom. economic process enabled banks to grow in size compared to the
countries within which they're placed (with Iceland as an extreme example). whereas monetary
development is usually good, it conjointly carries risks. If there's a recession, the primary order
of the business are to revive the worldwide economy. Few Governments will and will revive the
economy once there's recession, however it's unclear what number times will a rustic add 1020% of GDP to its national debt. A sufficiently solid government budget (i.e., low debt
compared to the government's ability to extend taxes) is that the solely viable thanks to defend an
economic system within the face of ruinous monetary troublesome. this needs counter-cyclical
economic policy throughout a boom, that is usually politically difficult in most countries.
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