Question

A. Sometimes in order to stimulate more consumer spending, the federal government will compel banks to relax lending standards for a time to entice more people and more business organizations to take out more loans than they would normally do under more restrictive standards.

Is the relaxing of lending standards a wise policy to implement from time-to-time, or is the risk to the overall economy too great to make use of such a policy? Explain in detail why or why not, and also keep in mind that such a relaxed standards policy played a significant role in the economic troubles the country endured primarily in 2007-2008.


B. Since business taxes increase the cost of doing business, and these lead to higher consumer prices and fewer investments, would both business organizations and consumers benefit from lower business taxes, or would only business organizations benefit? Explain.

Answer 1

A. No, relaxing standards is not a wise policy to implement from time to time as it involves risk to the overall economy. Relaxing standards to lend loans will lead to default in future. This is harmful for the entire banking industry and overall economy as well. The main reason of the financial crisis in 2007-08 was relaxation in standards by selling Mortgage Based securities (MBS) to the borrowers without checking their credentials correctly. This led to shutting down of few banks in the United States and government bailing out other banks. Thus, relaxation of standards is not a wise policy to implement from time to time.

B. Both consumers and businesses benefit from lower business taxes as it reduces the cost of production for the firm and thus the firms also decrease prices to capture the market. This decrease in prices increases consumer surplus for the consumers and thus also benefit consumers in the market. Thus, both business organizations and consumers benefit from lower business taxes.