Question

discuss the fiscal policy by addressing the following issues

A. what were the four general parts of the recovery act? what were the two largest categories of this act?

b. list each of the time lags associated with fiscal policy. approximately, how long is each lag.

C. describe "crowding out" and how it effects fiscal policy

D. when was the employment act passed and what were the major changes from this law?

Answer 1

A. The American Recovery and Reinvestment Act of 2009 (ARRA) is an economic stimulus package enacted by the 111th United States Congress and signed into law by President Barack Obama on February 17, 2009.An Act making supplemental appropriations for job preservation and creation, infrastructure investment, energy efficiency and science, assistance to the unemployed, State, and local fiscal stabilization, for the fiscal year ending September 30, 2009, and for other purposes.

ARRA allocates $787 billion to fund tax cuts and supplements to social welfare programs as well as increased spending for education, health care , infrastructure and the energy sector.

Four general parts of the act were:

1. To preserve and create jobs and promote economic recovery.
2. To provide investments needed to increase economic efficiency by spurring technological advances in science and health.
3. To stabilize State and local government budgets, in order to minimize and avoid reductions in essential services and counterproductive state and local tax increases.
4. To invest in transportation, environmental protection, and other infrastructure that will provide long-term economic benefits.

The Act specifies that 37% of the package is to be devoted to tax incentives equaling $288 billion and $144 billion, or 18%, is allocated to state and local fiscal relief which also accounts for two largest category of this act.

Largest categories of this act:

1.Tax incentives for individuals which consists a budget of $237 billion.

2. ARRA included the enactment of the Health Information Technology for Economic and Clinical Health Act, also known as the HITECH Act which comes with a total spending of $155.1 billion.

B. The time lags associated with fiscal policy:

In economics we often see a delay between an economic action and a consequence. This is known as a time lag.An impact of time lags is that the effect of policy may be more difficult to quantify because it takes a period of time to actually occur.As an example of a time lag in action, the Fed may cut interest rates, but it will take time to see these cuts reflected in the economy for the following reasons. First, homeowners with fixed-rate mortgages will not be able to take advantage of interest rate cuts until their loans come up for refinancing, which may take one to two years. During these two years, lower interest rates have not made any difference to the amount of disposable income for this group of individuals.List of various time lag associated are:

1. Change in interest rate (macro)
2. Increase in level of investment (macro)
3. Change in price of commodity (micro)
4. Effect of devaluation (macro) (J-Curve effect)

Time lags can make policy decisions more difficult. It is estimated interest rate changes take up to 18 months to have the full effect. This means monetary policy needs to try and predict the state of the economy for up to 18 months ahead, but this can be difficult in practise.A policy lag is the lag between the time an economic problem arises, such as recession or inflation, and the effect of a policy intended to counteract it.

C.Crowding out:

A situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending is called crowding out effect.The Crowding Out effect is a Monetarist criticism of expansionary fiscal policy.

The phenomenon, whereby increased government expenditure may lead to a squeezing of private investment expenditure, is referred to as the crowding-out effect. Gov­ernment expenditure crowds out private sec­tor investment expenditure. Thus, the multi­plier effect of government expenditure (KG) is lessened because of the negative effect on private investment following higher interest rates. It is because of the crowding-out effect aggregate output declines but interest rate increases.

How crowding out effects fiscal policy:;

Private investment is an important channel for the effectiveness of the fiscal policy in terms of increasing growth in the economy. Expansionary fiscal policy, by positively affecting private investment (crowding in) can lead to growth in total income of the country. However, it can also crowd out; i.e. decrease private investment by leading to an increase in interest rates. The effect of fiscal policy on private investment, therefore, becomes crucial due to its relevance to sustained economic growth. Crowding out, the Keynesian model argues that an increase in the government spending stimulates the domestic economic activity and crowds in private investment. According to Ricardian Equivalence theorem, increases in deficit financed by fiscal spending will be matched with a future increase in taxes and so they leave interest rates and private investment unchanged.

D.The Employment Act was an act of legislation enacted by the United States Congress in 1946, that charged the government with the responsibility of maintaining a high employment level of labor and price stability. These two goals are in direct conflict with each other, because as full employment is achieved consistently over time, demand-pull inflation will result.

When the act enacted the Act stated: it was the "continuing policy and responsibility" of the federal government to:

coordinate and utilize all its plans, functions, and resources. to foster and promote free competitive enterprise and the general welfare; conditions under which there will be afforded useful employment for those able, willing, and seeking to work; and to promote maximum employment, production, and purchasing power.

The act was the product of numerous revisions to what was originally introduced as the Full Employment Bill of 1945. It had declared:

All Americans able to work and seeking work have the right to useful, remunerative, regular, and full-time employment, and it is the policy of the United States to assure the existence at all times of sufficient employment opportunities to enable all Americans who have finished their schooling and who do not have full-time housekeeping responsibilities to freely exercise this right.The Employment Act of 1946 created the Council of Economic Advisers (CEA), a three-member board that advises the president on economic policy; required the president to submit a report to Congress within ten days of the submission of the federal budget that forecasts the future state of the economy and presents the administration’s domestic and international economic priorities; and established the Joint Economic Committee – composed of members of both political parties from both the House and Senate – that is charged with, among other things, reviewing the president’s report and making recommendations to the Senate and House on economic policy.