Introduction
An economy of a country goes through different cycles. There will be periods where there will be a boom and at other times there can be a recession. In the Western world the period 2007 to 2009 was a tough period as the economy went through a recession. Many people lost their jobs while others lost their homes. It is estimated that a total of 8.4 Million jobs were lost during the recession period. Mortgage products were the worst hit. Governments came up with measures to stimulate the economy. The American government spent a lot of money bailing out banks and mortgage companies.
There are two economic tools available to a government for manipulation in order to influence the economy. The government may either adjust their monetary or fiscal policies. Contractionary or expansionary measures may be taken. For monetary policy, the government may either increase the lending interest rates through banks in order to reduce credit availability in the market. It may also reduce the lending interest rates to increase lending by banks. The government may also adjust fiscal policies. Fiscal policy involves the use of adjusting government taxes and spending in order to stimulate growth (Monacelli & Perotti, 2008). An expansionary policy involves reducing taxes or increasing government expenditure. To achieve different market reactions the government may increase taxes or reduce government expenditure.
The American government has in the recent years chosen an expansionary fiscal and monetary policy. It has reduced taxes for businesses and individuals and at the same it has increased expenditure to deal with recession. The effect of an expansionary fiscal policy on output is shown below:
These actions have increased business and consumer expenditure, employment and exports. However, it has led to high budget deficits that have become a huge concern among scholars. There have been huge debates on the adverse effects of budget deficits in the long run. Another contentious issue has been the impact of the high expansionary fiscal policy on the current accounts deficits. The policy is seen to further aggravate the situation and the current account deficits will adversely affect the economy in the long run. In this paper I will discuss the relationship between the expansionary fiscal policy and the current status in the economy.
The Effects of the Expansionary Fiscal Policy on the U.S Economy
The American government used an expansionary fiscal policy to influence the American economy in times or recession or financial crisis. In 2009, when the country was in the midst of the financial crisis that had affected the Western world, the Obama administration passed $787 Billion stimulus package that entailed government spending and tax cuts. President Obama announced that the budget in 2011 would also be a high deficit budget. The spending for 2011 would be at $3.83 trillion. The budget deficit for 2010 was $1.56 trillion while in 2011; the budget deficit would be at $1.27 trillion in 2011. The government spelled out the aim of the expansionary fiscal policy. It was to stimulate business investment, encourage consumer spending, create new jobs and provide relief to the consumers.
The stimulus package is to roll for seven years till the year 2016. The country now runs on a high deficit balance where the government spending is higher than the revenue it is receiving. The revenue has been reduced due to the high tax cuts and reduced health care costs while the spending has been increased by the enhanced benefits and health insurance for the people who are currently unemployed and economic recovery payments of $250 million to the people receiving social security benefits. These people currently are over 52million. All these measures aim to increase the output of goods and services and increase employment leading to a very healthy economy (Eisner, 2008). Tax cuts increase the amount of money that individuals and businesses have causing them to spend more.
Looking at the effects of the expansionary fiscal policy, there has been positive spending. In the area of consumer spending, there has been an increase of household expenditure that is forecasted to increase later in the year and in the year 2012. During the recession, consumer spending had decreased due to decrease in employment. Many people faced job cuts. The fiscal policy has helped businesses spend more leading to higher employment rates. The unemployment rate is currently at 9.4% however it is expected to decrease to 9% by the end of year. In the year 2012, the unemployment rate is expected to be around 8% (Tilton, 2011).
The fiscal policy has affected labor market positively with employment rates expected to increase by 1.1% in 2011 and 1.8% in 2012. The employee compensation rates have also increased as employers are optimistic about the economy. Consumer spending on housing and automobiles has increased and is expected to increase. The consumer spending index had risen by 2.9% in 2010. However, moving forward, the rate will increase by 3.1% by the end of year and in the year 2012 it will rise by 3% (LAEDC, 2011). Business investment has also increased in the economy. Businesses usually invest in equipment and software. The expenditure is expected to rise by 0.9% in 2011 and 4.6% in 2012.
The increase in spending by businesses has also affected the balance of payments or the current accounts. This is the comparison of the country’s exports and imports. Businesses have picked up and they are now importing higher values of capital goods, motor vehicles and parts and consumer goods. The U.S imports are expected to increase by 4% and 6.5% in 2011 and 2012 respectively.
The increase of government spending causing a high deficit budget has been greatly criticized. This is because the economists are concerned with the high public debt. To get funds the government issues government bonds which businessmen buy. However this ends up crowding out private investments which in the end will cause slow growth in the economy (Gale & Orszag 2003). To attract business to purchase the bonds, the government has to offer the bonds at high interest rates. This causes the government to repay the public debt at higher rates. In the long run, the money that the government would have used for public expenditure on critical areas such as education and healthcare is instead channeled to repayment of public debt (Sidiqi & Ilyas, 2011). In the long run in order for the government to be able to pay the public debt, they will have to increase taxes in the future. The increment of taxes will again serve to discourage investment in the future. This goes to reverse the positive effects of the fiscal policy on employment.
The budget deficits have also played a role in increasing the current account deficit (Engels & Rogers, 2006). An expansionary fiscal balance ends up causing the domestic currency to appreciate in a situation where the consumers and businesses have a higher demand for goods
and services than the rate of production in the economy. This causes the dollar to rise higher than the foreign currencies and therefore leads to inflation (Metin, 1998). The consumers and businesses will therefore prefer to import goods and pay in foreign currency. This situation worsens the current account as the imports continuously become higher than the exports.
The net exports contribute to the growth in the country’s economy. The current account has been at a deficit for a while. Looking at the current account deficit, it was at -$421Billion end of year 2010. It is expected to improve and operate at -$402 Billion however in 2012, it will worsen and operate at -$452 Billion in 2012. These current accounts need to be addressed or they could lead to a further declining real exchange rate of the dollar (Mann, 2002) Other factors that have contributed to the high current account deficits are low savings by the private market and the government as shown by the high deficit budgets (Hubbard, 2006) Economists have argued that the high deficit should not be alarming since in the long run it will adjust and stabilize.
Conclusion
The well-intended impact of an expansionary fiscal policy depends on other factors in the economy. It depends on whether the economy has spare capacity to produce goods and services. Expansionary fiscal policy adverse effects should be mitigated in the long run. To boost up the economy, the expansionary measures worked to increase employment and output. There was job creation and high consumer expenditure.
The concerns however are the high budget deficits and high current account deficits and the impact it will have in the economy in the long-run. Most fiscal policies however are put to deal with economic recessions in the short term.
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