Question

1. what is the difference between the actual deficit, the full enployment deficit and the preformance of the economy between years 1 and 2

2. what fiscal policy is most likely to be invoked during a period of rapid inflation. a period of severe unemployment? what political, investment and international problems might the government encounter in enacting these policies and putting them into effect?

Answer 1

1) Actual Deficit in any given year is the actual or nominal deficit adjusted for inflation' effect on the debt. The actual deficit is the difference between the government's actual revenue and expenditure.

Full employment deficit is a term denoting the budget deficit that would have existed if the economy had been at full employment: estimated by excluding recession--induced increase in public expenditure and reductions in revenues from taxation, that is synonymous with term cyclical KY adjusted budget deficit. It occurs when the national economy is at full employment, yet the federal budget is still operating at a deficit.

Difference between Actual Budget Deficits and Full-employment deficit and the preformance of the economy in year 1 and year 2:

a. When the economy is in recession, the full-enployment deficit is less than the actual deficit because the economy is below potential GDP, and the automatic stabilizers are reducing taxes and increasing spendings.

b. When the economy is performing extremely well, the full-enployment deficit is higher than the actual deficit because the economy is producing about potential GDP, so the automatic stabilizers are increasing taxes and reducing the need for government spending.

c. During the recession, like the early year 1 and year 2, the full-enployment deficit is smaller than the actual deficit, the automatic stabilizers tend to increase the budget deficit, so if the economy was instead at full employment, the deficit would be reduced.

2) Fiscal policy is how the government influences the economy by using taxes or spending to control economic growth. Fiscal policy is also used to curtail inf, increase AD and other macroeconomic issues.

a) Contractionary Fiscal Policy  The government will invoked contractionary fiscal policy during a period of rapid inflation.

Contractionary fiscal policy is employed when the growth of the economy is unsustainable and is causing inflation, high investment prices, unemployment below healthy levels. Contractionary fiscal policy entails increasing tax rates and decreasing government spending in hopes of slowing economic growth for various reasons in this way, the government may deem it necessary to halt or deter economic growth if inflation caused by increased supply and demand of cash gets out of hand.

b. Expansionary Fiscal Policy-The government will invoked expansionary Fiscal Policy during a period of severe unemployment.

This policy is used by the government when attempting to balance out the contraction phase of the business cycle and use methods like cutting taxes or increasing government spending on things like public works in an attempt to stimulate economic growth. The goal behind the expansionary fiscal policy is to lower tax rates and increase consumer aggregate demand, which will increase demand for products, requiring businesses to hire more employees to support the higher demand and thus increase employment.

Problems that government might encounter in enacting contractionary and expansionary fiscal policies and putting them into effect are as follows:

a. Political: Politicians will rationalize actions and policies in their self-interest. They will support fiscal policy that is popular in order to get re-elected and avoid the policy which is unpopular.

There could be a lag in implementing a policy decision, and/or the impact of a policy. For example, by the time the policymakers recognize the problem and take decision to do something, it may already be too late. Once the government implements a policy, there may be a time lag till the policy has an impact on the economy.

c. Investment : An expansionary Fiscal Policy may end up decreasing aggregate demand because of crowding-out effect. Increased government borrowing leads to an increase in interest rate, which leads to a decrease in aggregate demand.

The economy may be slow due to shortage of resources rather than lower demand. In this case, fiscal policy will not help. Since expansionary fiscal policy increases fiscal deficit, there is constraint over how much deficit the government can tolerate.

c. International: In an open economy, fiscal policy also affects the exchange rate and the trade balance. The rise in interest rates due to government borrowing attracts to get more dollars to invest, foreigners bid up the price of the dollar, causing an exchange rate appreciation in the short-run. This appreciation makes imported goods cheaper and exports more expensive abroad which decrease aggregate demand and thus causing recession.