US Fiscal Policy - Will It Help Economy
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With concerns over an impending recession, it appears that fiscal policy is
becoming more popular amongst politicians and policy makers. For example, in the
US, the slowdown in the economy is causing politicians from across the political
spectrum to argue for varying degrees of fiscal expansion. As Nixon said in the
late 60s, are we all becoming Keynesians again?
How Fiscal Policy Works
Fiscal policy is the governments attempt to influence Aggregate Demand AD,
and therefore influence the economic cycle and economic growth. If the
government wish to boost domestic demand, they can cut taxes and increase
government spending. Lower income tax increases the disposable income of
consumers, hopefully causing them to spend more. Therefore, this will cause
higher levels of economic growth.
The downside of expansionary fiscal policy is that the government will need
to borrow more from the public sector so that they can finance the tax cuts.
This increases the national debt and future interest payments, which ultimately
the tax payer must pay back.
Why Fiscal Policy May not work
Although in theory the government can influence the level of economic
activity. In practice it might be difficult for the government to actually
manage demand as much as it likes.
1. Consumer Confidence. If consumer confidence is low, a cut in income tax
may not encourage spending. The reason is that they prefer to save the tax cut,
rather than spend. Therefore there is no increase in domestic demand. This
scenario is particularly likely when taxes are cut for the rich; high income
groups have a lower marginal d to consume.
2. Crowding Out. This occurs when higher government spending and borrowing
lead to a corresponding decline in private sector investment and spending. The
reason is that the government spend more, but borrow from the private sector. If
the private sector buy government bonds, it means they have less income to spend
and invest. Therefore, the government is merely diverting resources from the
private sector to the public sector, and therefore there is no increase in
overall Aggregate Demand.
Furthermore, government spending may be more inefficient than the private
sector. Also higher levels of borrowing may push up interest rates, further
crowding out private sector spending.
However, Keynesians dispute this. They say that in a genuine recession,
private sector resources are under-utilised and therefore, the government is
merely helping to kick start the economy.
fiscal policy and the economic mistakes of politicans
About the Author
Richard Pettinger studied Politics and Economics at Lady Margaret Hall,
Oxford University. He now works as an economics teacher in Oxford. He enjoys
writing essays on Economic and he edits an Economics Blog focused on UK and US
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Article Published/Sorted/Amended on Scopulus 2008-02-22 11:57:12 in Economic Articles