Question

In the 2020/21 Hong Kong Budget, Financial Secretary announced a HK$120 billion relief package, including cash payout, salary tax reduction and other stimulus. Discuss the theories that give support to the adoption of the stimulus packages, and explain the extent to which you would, or would not, agree with the policies. Please write the detailed answer.

Answer 1

In any economy, aggregate demand should keep shifting right and it should be complemented by shift in aggregate supply as well so that economy potential goes up without inflationary impact on an economy. This will be helped by both demand and supply side policies as shown in figure below. It also helps LRAS to shift right.

Fiscal policy is a policy controlled by the government and it has two tools: taxes and govt. spending.During recessions govt. decreases taxes and increases govt. spending which is called expansionary fiscal policy. Stimulus package is given to cover this recessionary pressures and create more jobs with more GDP. This is a policy followed by many governments. For example- USA in 2008, India and many others in 2020 to fight COVID-19 impacts. It creates immediate short run activity with job generation, may support supply side also to produce more.

However, government stimulus creates fiscal defict and also makes country indebted. Crowding out effect also takes place.

When budget deficit is higher then in order to keep accounts intact government has to borrow money and as government needs more money, demand for money goes up and as demand goes up, interest rates also go up. Private investors will borrow and spend less. This drives out efficient private investments.