Question

Fiscal Policy entails government spending and taxes to restore the economy back to equilibrium and a stable growth path. Considering the current state of the economy, what policy(ies) do you think government need to implement to alleviate the current economic hardship?

Answer 1

World is having a severe recession due to COVID-19.

Recession is when real GDP growth is negative for six months. To avoid recession there should be enough aggregate demand in an 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.

Demand side policies:

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. During inflation govt. increases taxes and decreases govt. spending which is called contractionary fiscal policy. Monetary policy is a policy determined by central bank and has two tools; interest rates and money supply. When there is inflation and central bank wants to reduce over consumption in an economy then it increases interest rates and decreases money supply. This is called as contractionary monetary policy. When there is recession and central bank wants to boost economic activity then it decreases interest rates and increases money supply. This is called as expansionary monetary policy.

Expansionary policies create more aggregate demand, decrease unemployment. It can be inflationary if all resources are fully used and there is no spare capacity.

Supply side policies: This policy focuses on aggregate supply. It has two types- market based and interventionist based. market based policy focuses on incentives for businesses, labor market reforms and encouraging competition. Interventionist based policy focuses on human and physical capital.

If all these polices are used effectively along with focus on innovation then country may avoid recessionary impacts.

Real life examples:

USA announced $2 trilllion, India announced 1.7 lakh crore rupees, Britain 15% of GDP and Germany 20% of GDP as packages to bring economy out of recessions and provide economic stability. All over the world governments are intervening in financial markets. Central banks are also reducing interest rates and making sure that there is enough liquidity in the markets. Loans restructuring for households as well as businesses will also start. Money transfer in peoples account is also started.

Hence expnasionary fiscal and monetary policies along with supply side (retraining and emphsis on education)is needed the most.