Expansionary fiscal policy boosts aggregate demand by increasing government expenditure or lowering tax rates. Expansionary policy can achieve this by: (1) increasing consumption by increasing disposable income through personal income tax or payroll tax cuts; (2) increasing investment spending by increasing after-tax profits through business tax cuts; and (3) increasing government purchases by increasing federal government spending on final goods and services and increasing federal grants to state and local governments to increase their final goods and services expenditures. Contractionary fiscal policy works in the other direction, lowering aggregate demand by reducing consumption, investment, and government spending, either through cuts in government spending or tax hikes. The aggregate demand/aggregate supply model is important for determining whether fiscal policy should be expansionary or contractionary.
Consider the situation in (Figure), which is similar to the economy in the United States during the recession of 2008-2009. As the LRAS curve shows, the intersection of aggregate demand (AD0) and aggregate supply (SRAS0) occurs below the level of potential GDP. A recession occurs when the equilibrium (E0) is reached, and unemployment rises. In this instance, expansionary fiscal policy, such as tax cuts or increases in government expenditure, might move aggregate demand to AD1, bringing output closer to full employment. Furthermore, the price level would return to the P1 level, which corresponds to potential GDP.
In a recession, how is fiscal policy implemented?
- The use of government spending and tax policies to impact economic circumstances is referred to as fiscal policy.
- Fiscal policy is largely founded on the views of John Maynard Keynes, who claimed that governments could regulate economic activity and stabilize the business cycle.
- During a recession, the government may use expansionary fiscal policy to boost aggregate demand and boost economic growth by decreasing tax rates.
- A government may follow a contractionary fiscal strategy in the face of rising inflation and other expansionary signs.
During the 2008 recession, what fiscal policy was implemented?
The Economic Stimulus Act of 2008, a $152 billion stimulus aimed to help avoid a recession, was passed by Congress in 2008 and signed by then-President George W. Bush. The majority of the package was made up of $600 tax rebates for low and middle-income Americans.
The American Recovery and Reinvestment Act of 2009, a $787 billion package encompassing a range of expenditures from tax rebates to corporate investment, integrated various stimulus programs. $184.9 billion would be spent in 2009, $399.4 billion in 2010, and the rest of the bill’s funds would be spread out throughout the rest of the decade. An announcement of a rescue plan was connected with positive returns, whereas a public intervention in favor of a single bank was associated with negative returns.
What are some fiscal policy examples?
Tax cuts and increased government expenditure are two primary elements of expansionary fiscal policy. Both of these programs aim to boost aggregate demand while also contributing to budget deficits or draining surpluses.
What is the role of fiscal policy?
The employment of government spending and taxation to impact the economy is known as fiscal policy. Fiscal policy is often used by governments to foster strong, long-term growth and poverty reduction.
What effect does monetary policy have on recession?
Adjustments to interest rates and the money supply, known as monetary policy, can help to combat economic slowdowns. Such adjustments can be made swiftly, and monetary authorities commit significant resources to economic surveillance and analysis. Lower interest rates cut the cost of financing for big-ticket items like cars and houses, which can help to counteract a slump. Monetary policy can also lower the cost of investment for businesses. As a result, lower interest rates can benefit the economy by increasing expenditure by both people and businesses.
The Federal Reserve can make monetary policy changes faster than the president and Congress can make fiscal policy changes. Because most economic contractions endure only a few quarters, timely policy responses are critical. In fact, however, fiscal policy responds slowly to changes in economic conditions: it takes time to enact and then implement a stimulus measure, as well as time for spending increases or tax reductions to reach consumers’ pockets. As a result, the fiscal stimulus’ impact on consumer and business expenditure may be delayed.
The extent to which and how much stimulus is required is determined by current economic conditions, future projections, and potential dangers to both economic growth and inflation. Given the constraints in the data available and economists’ understanding of the world, forecasting economic conditionsor even determining the current status of the economyis intrinsically challenging. However, the Federal Reserve’s vast and professional team of experts is better positioned than any other federal agency to complete this duty. Furthermore, the Federal Reserve personnel works without regard for political factors.
However, monetary policy’s ability to resist catastrophic events is limited because its main tool is the short-run interest rate, which cannot fall below zero. That means that in a particularly severe downturn, such as the previous Great Recession, the Federal Reserve will cut the short-term interest rate to zero, limiting the Fed’s options to less effective and well-understood strategies like asset purchases. In similar circumstances, fiscal policy may be able to assist monetary policy in stimulating the economy.
What are the executive and legislative branches of government’s two fiscal tools?
A few factors, like as GDP, are often used to gauge an economy’s success. Another aspect is aggregate demand, which is the total amount of goods and services produced by a country that are purchased at a certain price. According to the aggregate demand curve, more products and services are demanded at lower price levels, while less is demanded at higher price levels.
Fiscal policy has an impact on these indicators, with the goal of increasing GDP and aggregate demand in a long-term way. This is accomplished by altering three factors:
- Business tax policy: Profits and investment are affected by the taxes that firms pay to the government. Lowering taxes boosts aggregate demand and investment spending by businesses.
- Government expenditure: The government’s own spending boosts aggregate demand.
- Individual taxes, such as income taxes, affect an individual’s personal income and the amount of money they may spend, thereby infusing more money into the economy.
When an economy’s aggregate demand is low and unemployment is high, fiscal policy usually has to be modified.
Taxes and spending are the two basic weapons of fiscal policy. Taxes have an impact on the economy because they determine how much money the government has to spend and how much money people should spend. For example, if the government wants to encourage consumer spending, it can lower taxes. Tax cuts provide extra money to families, which the government hopes will be spent on goods and services, boosting the economy as a whole.
Spending is a technique used by fiscal policymakers to direct government funds to certain sectors in need of assistance. Whoever receives those dollars will have more money to spend, and the government expects that this money will be spent on other products and services, just as it is with taxes.
Finding the appropriate balance and ensuring that the economy does not lean too far in either direction is the key. Prior to the Great Depression in the 1920s, the United States government had a hands-off approach to economic policymaking. Following that, the US government felt it needed to play a bigger role in defining the economy’s course.
One of the issues with employing fiscal policy to minimise the severity of the business cycle is which of the following?
One of the issues with employing fiscal policy to minimize the severity of business cycles is which of the following? It is frequently put in place too late to be effective.
What is the purpose of a fiscal stimulus package?
Stimulus packages are made up of a variety of government tax and expenditure policies. When the government enacts fiscal stimulus, it gives money to individuals, businesses, and even entire industries that are affected by a slump through direct subsidies, loans, or tax incentives.
The Center on Budget and Policy Priorities (CBPP) claims that “During a recession, the federal government uses fiscal stimulus to boost household and business demand for goods and services by increasing spending, cutting taxes, or both.”
However, economic hardship is more than just a matter of supply and demand for goods and services. The human cost of a recession could be the most devastating aspect of any catastrophe.
These human costs were quantified in a 2010 research paper by the International Monetary Fund, which included “Loss of lifetime wages, human capital, worker dissatisfaction, negative health consequences, and societal cohesiveness.” In addition to economic losses, recessions inflict intangible scars, all of which may be avoided or reduced with a well-structured and timely stimulus plan.
There’s a reason they’re called packages: Stimulus packages often consist of a variety of subsidies, bailouts, tax rebates, and supplementary unemployment compensation to address a variety of economic issues.
In a downturn, some policies are focused on industries and economic sectors that are facing special difficulties. Others attempt to assist folks who have lost their jobs. Some are intended to promote expenditure across the economy as a whole.
Industry Bailouts
Bailouts of businesses are one of the most popular types of fiscal stimulus. And these acts frequently occur in the absence of a broader economic crisis. Low-interest loans, loan guarantees, and even direct subsidies can be aimed to individual enterprises or an entire industry.
A good example of a narrowly targeted effort is the airline industry bailout following the terrorist attacks of September 11, 2001. Following the attacks, Congress provided $10 billion in loan guarantees and $5 billion in direct assistance to help the airline industry get through the crisis.
During the Great Recession, there were industry bailouts aimed at saving entire sectors of the economy. The banking sector, housing industry, and automakers were the hardest damaged during the crisis, which lasted from 2007 to 2009 and has yet to fully lessen. The Troubled Asset Relief Plan (TARP) was enacted in response, with the initial goal of purchasing $700 billion in “troubled assets” from only the financial sector.
Ironically, very little TARP money was utilized to buy assets of any type, instead bailing out failed insurance behemoth AIG, the car industry, and a substantial section of the US financial sector. Although proponents like to point out that TARP rescues netted the federal government more than $110 billion in the long term, there is ongoing dispute about the prudence of these bailouts.
The Covid-19 pandemic has once again pushed the airline industry to the brink of bankruptcy, as nationwide lockdowns have halted most travel. Billions of dollars were set aside in the CARES Act for a bailout of the airline industry. The assistance came with stipulations, such as a moratorium on layoffs until September 30, a restriction on stock buybacks, and a halt to CEO pay rises.
Tax Incentives
Taxes are believed to be as unavoidable as death, except when the economy is in a slump. A common component of stimulus packages is the reduction or elimination of certain taxes or the provision of tax rebates.
Tax incentives, in whatever form they take, aim to put more money in the hands of corporations or in your wallet. Individuals and businesses are expected to spend the extra money, resulting in increased economic activity.
To alleviate the economic gloom that had settled over the United States in the first half of the 1970s, President Gerald Ford proposed a stimulus package in 1975 that mostly depended on tax policy. An OPEC oil embargo, a currency crisis triggered by the United States abandoning the gold standard, and a slew of other economic woes pushed the United States into a protracted recession that lasted from November 1973 to March 1975.
In March 1975, Congress enacted President Ford’s tax stimulus package. It doubled the standard deduction, established a refundable earned income tax credit, and granted all taxpayers a $30 tax credit (worth roughly $140 in today’s currencies).
According to the Economic Policy Institute, the tax incentives benefited the economic recovery by driving a recovery in consumer spending that lasted until the end of the decade.
The CARES Act provides a financial incentive in the form of a refundable payroll tax credit among its many components. The purpose of the Employee Retention Credit, as it was officially known, was to encourage firms to keep people on the payroll even if they weren’t working. For earnings paid between March 13 and the end of 2020, eligible companies receive a payroll tax credit equal to 50% of wages paid per quarter, up to $10,000 per employee.
Direct Subsidiesaka Stimulus Checks
Direct payments to citizens may be the most effective way of giving fiscal stimulus. According to the hypothesis, if you give someone money, they will most likely spend it on something. But it’s not just common sense; research back up the claim.
Direct payments in the form of stimulus checks are a relatively new phenomena as compared to industry bailouts and tax incentives. The Economic Growth and Tax Relief Reconciliation Act (EGTRA) delivered tax rebates (as a result of tax reduction) as checks during the brief recession of 2001. These were a combination of a tax incentive and a direct stimulus payment.
The American Recovery and Reinvestment Act of 2009, passed seven years later during a totally different economic crisis, provided qualifying taxpayers with a refundable tax credit of $400 per individual and $800 per couple. In the form of tax-free stimulus checks, money was distributed directly to eligible Americans.
The much-lauded stimulus checks were one of the CARES Act’s pillars, though they weren’t attached to a tax credit or a tax reduction. Individuals with incomes of less than $99,000, or $198,000 for joint filers, were eligible for one-time Economic Impact Payments of $1,200 per adult and $500 per kid under the age of 17a total of $3,400 for a family of four.
For some time, we will not have evidence to demonstrate the efficacy of the CARES Act stimulus checks. However, according to a recent research article from Northwestern University’s Kellogg School of Management, households spent half of each stimulus check in the same quarter that it was received.
Supplemental Unemployment Benefits
High unemployment is one of the hallmarks of a recession. People standing in line or loitering around a job fair in search of jobs is an iconic image of any economic downturn. As unemployment rises, the demand for unemployment benefits tends to overwhelm the state’s resources for implementing unemployment insurance systems.
Special additional cash is frequently directed to states in stimulus packages to enable them prolong unemployment benefits beyond the customary cut-off dates and to enhance the size of each payment.
During the Great Recession, the American Recovery and Reinvestment Act gave state unemployment insurance benefits a federal extension of up to 33 weeks, as well as a tax break on the first $2,400 in benefits.
The CARES Act provided unemployed workers with an extra $600 per week on top of the state benefits they were already getting.
President Trump signed a memorandum on Aug. 8 approving $300 per week in federal unemployment benefits for a limited time as that funding ran out and Congressional leaders could not agree on more funding. However, each state was needed to apply for the money, and not all did. South Dakota, for example, dropped out of the program after determining that they did not require the extra help.