Question

Imagine that you are a government advisor during the COVID-19 crisis when there is a large recessionary gap. You are working on the governments fiscal stabilization policy that will be implemented as the crisis subsides. What are the government’s options in terms of government spending G? What are the pros and cons of each option? (Hint: consider whether you expect private aggregate demand to rebound quickly after restrictions are lifted.)

Answer 1

Some of the main problems we have seen during this crisis is shortage of supply, unemployement which gradually reduces spending leading to the fall of the aggregate demand. The options of government in terms of government spending are

1. Tax cuts: There are different types of tax cuts like income tax,coperate tax,dividends,capital gains and small business. Reducing tax will increase the money in the hands of the consumers which will encourage them to spend more increasing demand, cutting down coperate, small business and capital gains will encourage companies to invest in icreasing production by taking precautionary methods to protect the health of the people working to increase supply and reduction in unemployement. The major disadvantage of tax cut is that government is loosing one of the main sources of income, this will also increase the government borrowings leading to an increased debt.
2. Subsidies:There are two types of subsidies which are direct subsidies and indirect subsidies, direct subsidies include allocation of fund to a particular industry, group of industries or to individual firms. Indirect subsidies government involvement in price reduction, for example reduction of prices of raw materials for agriculture. These subsidies will help in increasing production improving supply and creates employment. High employment creates purchasing power and increased supply will allow to meet the consumer demand, thus shifting the aggregate demand curve to the right. Disadvantage of the subsidies is that, at this point of time the government is already exhausted and even during recession some companies might have the resources to keep the production going and subsidies will only be helping them to maximize profit.
3. Payment transfer: More like direct subsidies, funds are allocated and transferred to the bank account of the beneficiary. These transfers are done for medicare, social security and welfare programs. These transfers will ensure safety of people, improving medical facilities and precautious measures to prevent the spread of the virus. Ensuring safety of people providing free tests and treatments at lower rate will reduce mortality rate and spread of the virus. The faster the state recovers from this pandemic the faster lives of people will get back to normal, which will slowly increase spending and increases aggregate demand and supply. Disadvantage is that improper allocation o resources can lead to loss of fund and inefficiency.