Question

           

1. Outline how counter cyclical fiscal policy and balanced budget fiscal policy would close a recessionary gap. Be specific on goals, how each theory would achieve those goals, how they would close the gap, and potential negative effects.

Answer 1

cyclical fiscal policy is the policy introduce by the government to control the inflationary and recessionary pressure in the economy. They are two type of fiscal policy expansionary and contractionary. Expansionary fiscal policy introduce when there is recession in the economy and contractionary fiscal policy introduce when there is inflation in the market. The fiscal policy act as a stablizer to stablize the economy.

In above case there is recessionary gap. So to control the recessionary gap we use expansionary fiscal policy. In this fiscal policy either government increase spendings or decrease tax rate sometime do both. This policy helps to creat empolyment, generate more production, increase consumption. So through all this goverment reduces the gap of recession.

The negative effects of cyclical policy - As we know government reduce tax rate and increase its spending it causes budget deficit in the future and then government reduces its spending and increase tax rate causing crowding out effect.

Balanced Budget Fiscal policy tries to increase the aggregate demand by the changings its spending and tax rate level. In the balanced Budget fiscal policy increase its spending and also increase the tax rate equally. It means all revenue increase due to tax rate increase, should be spend by the government to reduce the gap of recession. The idea behind is that if you increase spending and taxes equally, the increase in government spending have more positive impact on economic growth than the negative impact of higher taxes..

negative effect of balance budget fiscal policy - If government increases its spending in the wrong area or sector. For example government increase spending on pensions so it not helps the economic growth as much as we want to nutralize the increase in tax rate. So government should spend on capital investment which helps the economic growth and reduce gap of recession.