Question

Suppose that there is an urgent need for new school buildings and teachers that emerged after hurricane Harvey in Houston, Texas. Answer the following questions about grants.

a. Explain why a block grant, in comparison with a matching grant, would result in less consumption education services (e.g., school buildings and teachers) but more of other goods according to your textbook.

b. Explain how a matching grant (for school buildings and teachers), in comparison with a block grant, would have a further impact via the spending multiplier?

Answer 1

a. First let us see what a matching grant means and what a block grant means.

A block grant is referred to a situation where in the federal government provides grants or large sum of money to the regional government. The regional government can use this grant for a wide range of purposes i.e. the Federal government does not provide specific guidlines as to to how the grant money is to be spent. A Matching grant, on the other hand, is also a type of grant provided to the Regional government, but the Federal Government also provides specific guidelines as to for what purpose and how the grant is to be used. In the above situation, providing a block grant would give more freedom for the regional government to spend on other needs deemed to be more immediate in case of a hurricanse. For example, the regional government may feel necessary to spend the grant on providing food and shelter first to the victims of the hurricane than providing educational services such as school buildings and teachers. Since the grant provided by the Federal government does not provide any restrictions on how the grant should be spend, one might find that the block grant sums, initially given with a motive to provide education services, are being used for other more urgent services. In contrast, a matching grant by definition restricts the regional government to spend the money on education services. Thus, a Block grant would result in a lesser consumption of education service, in comparasion with a matching grant.

b. The spending or fiscal multiplier refers to the ratio of income to government spendings. It meausres how a change in government investments and spending would effect the overall GDP in a country. It is a reciprocal of Marginal Propensity to Consume. Suppose the government increases its expenditure, this would result in income for the households (in various forms such as wages, rent). Given the Marginal propensity to consume for the consumers, these consumers would consume x% of the increased income. As consumption increases, it will in turn increase income once again and the consumers would again increase consumption; and so on. The overall effect is an increased GDP. The government spending/expenditure in the above example would be in the form of a grant (be it block or matching), which through this concept of spending multplier mentioned above will increase GDP in the economy.