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The monetary and fiscal policy implemented in the United States during the Great Recession and determine the short run and long - Essay Example

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The Monetary and Fiscal Policy Implemented in the United States During the Great Recession I. Introduction The Great Depression in the United States has become a central point of discussion for fiscal policy makers. Every fiscal decision appears to be referenced to the depression that has ravaged the U.S…
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Download file to see previous pages These subjects affect all players in the economy. In addition, some concepts will be explored and discussed in relation with the depression. II. Crowding Out The concept of crowding out pertains to the increase in government borrowing leading to reduction in consumption and investments (Blanchard, 2008). When the government decides to bolster spending, the best ways to raise funds are increased taxes and borrowing. In periods when depression is imminent, raising taxes is not a practical strategy. Government will have a hard time convincing the labour force to pay more taxes when community prices continue to rise and jobs become hard to maintain. The logical approach for the government to raise funds is to borrow through treasury bills, sovereign bonds and loans. The proceeds from these activities can used to pump the economy and stabilise spending among all entities. The immediate impact of crowding out can be observed in the investments. When the government borrows, there is a possibility that the interest rates will increase. As interest rates go up, the capacity of private investors to borrow decreases. High interest rates discourage investors to venture in activities that require massive funding. Aside from increasing the interest rate, government borrowing also create problems for companies to borrow from other channels. For instance, when a sovereign bond and a corporate bond are floated debt investors will have to decide which investment would sense (Blanchard, 2008). Governments compete with companies for funds and such hampers any expansion firms have in their pipeline. Some economists would argue that government borrowing is critical during times of depression. The inability of the private sector to sustain growth creates problems for the government (Spencer and Yohe, 1970). Long-term effects of crowding out appear to be beneficial in many ways. More funds in the public sector means spending for infrastructure and other aspects that could aid businesses. Also, the government could start handing out jobs to individuals affected by companies filing for bankruptcy and downsizing firms. When used the right way, government borrowing can fuel lagging economies and facilitate the revival of private investments and consumption. III. Ricardian Equivalence Theory The main proponents of the Ricardian Equivalence theory suggest that consumer will not change even if the government decides to increase taxes. The theory also states that the method in which governments finance their spending has to impact on the overall demand in the market (Barro, 1979). In times of recession and even especially during depression, governments are pressured to spend more. Since businesses start to slow down and consumer spending could also lag, revenue from taxes is expected to be reduced. To cover for the possible budget deficit governments could resort to borrow from available channels. Even if the borrowings will continue to rise, the level of consumption and overall demand will remain the same. According to Buchanan (1976), however, there are several aspects that were not considered when the theory was formulated. There is a difference in perspectives when dealing with borrowing and raising taxes. In addition, the promoters of the theory failed to recognise the varying opinion of the consumers when taxes are increased. Some households value their savings and considered their extra assets as insurance for their families’ ...Download file to see next pages Read More
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