Question

State and explain three of the pros and three of the cons of borrowing to finance government spending to stimulate the economy when in recession (200words)

Answer 1

There are different pros of borrowings used to finance government spending in recession. The first pro is that it helps build positive sentiments about the economy and people also start spending money that contributes in increase the demand. It is a boost to revive the economy. The second pros is that it helps in creating employment where people get jobs and spend money to increase in purchasing power. It further boosts the demand in the economy and firms start their investment planning. The third pro is the multiplier effect that is used to scale up the increase in output. It is driven by marginal propensity to consume and government spending leads to help economy come out of the recession.

Though there are some cons as well. The first con is the crowding out effect. Borrowing by the government leads to increase in rates in the market and cost of investment spending by the firms, increases. So, it is a discouragement to the firms. Hence, benefits achieved from the government spending, is offset by the decrease in investments by the firms. The second con is the spending of consumers depending upon the permanent income. Hence, temporary rise in spending, does not encourage consumers as they think that tax will increase in the future to recover the spending. So, they spend less. The third con is the government spending to supply side economy, does not pass on to the consumers. Rather, firms keep these funds to safe havens and do not transfer the benefits to consumers. Hence, it is a disadvantage.