Question

Compare and contrast the use of government spending changes versus tax changes as a means of influencing the course of the economy. Is one or the other preferable in specific situations?

Answer 1

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Question:

Answer:

Government adopts contractionary or expansionary fiscal policy according to the the health of the economy. During the recession the government increase government spending or cut taxes. During the recession increasing spending is more effecting than taxes cuts. During the recession the confidence level of the consumers and investors is very low. Due to the uncertainty about the future economic trend or growth the investors and the consumers do not want to invest and spend. If the government cut taxes then cut taxes do not affect investment and consumption more. But, if the government increase spending then its increase income level and increasing income level increase AD. Increasing AD increase output and price level. Increasing price increase investment that increase production and increasing production increase income level and decrease unemployment. Increasing income again increase AD that boost the economic growth. The objective of taxes cuts and increasing spending is increase AD. Decreasing AD is the main reason of economic down fall. Taxes cut increase disposable income other side increasing spending increase income level. So, the impact of both the things is same and increase income level but during the economic recession increasing spending is more affective in short-run compare to taxes cut.

But during the boom phase increasing taxes is more effective and help in increasing government revenue. During the recession fiscal deficit increase rapidly and increase interest burden on the government. So, increasing government revenue help in paying debt and also help in countering or decreasing inflation. During the boom phase inflation is high and increasing taxes decrease disposable income and its decrease AD. Decreasing AD decrease price level and output.

When government spending increase then its increase fiscal deficit. The gap between spending and revenue increase rapidly. So, full the gap or for funding the spending, the government borrow money through issuing securities. The government sell securities and raise money to full the fund requirement. When the government increase borrowing then its increase supply of securities in the market . The government securities are the safest securities and people invest in in bulk. During the recession when the there are huge risk in market the government securities give a better option for investment. Increasing borrowing increase demand for loanable fund and and increasing demand for loanable fund increase interest rate. Increasing government borrowing decrease or negatively affect to the private investment. Higher interest rate making borrowing costly for the private sector.  If the government borrows directly from the central bank or by printing money, there is an increase in money supply which may subsequently cause price inflation to rise. Other side increasing inflation depreciate domestic currency rate that makes foreign investors less willing to hold that countries debt. So, these impacts negatively affect to the economy

Normally the government increase spending and cut taxes and during the boom phase decrease spending and increase taxes but increase tax more. So, final decision is based on the current economic problem or issue. Some time during the recession inflation (cost-push) is high and increasing spending do not effective and the government gets confuse how to handle the situation. So, there is not any specific rule of principles to handle the different economic situation.

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