Question

The corona crisis and fiscal policy:

Some believe that the state should face the crisis with increased spending over the state budget. Is this a good idea before the anti-infection measures are lifted? Justify the answer with the AS-AD model.

Answer 1

Hi,

I hope you are doing well!

COVID-19-

COVID-19 crisis also known as Corona crisis global. It is a global pandemic situation. COVID-19 is much more than a health crisis. By stressing every one of the countries it touches, it has the potential to create devastating social, economic and political crises that will leave deep scars.

The world has shut down all the economic activities are mostly closed. All the manufacturing industry, malls, market, institutions, traveling, tourism industry affected worst. Major part of world's Population are staying at home. more than 55 lacs of global population are Corona positive and more than 3.5 lacs people have lost their lives.

Recession-

A period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. A recession is a period of economic contraction, where businesses see less demand and begin to lose money. To cut costs and stem losses, companies begin laying off workers, generating higher levels of unemployment.

Fiscal Policy-

Through the fiscal policy, the government of a country controls the flow of tax revenues and public expenditure to navigate the economy. If the government receives more revenue than it spends, it runs a surplus, while if it spends more than the tax and non-tax receipts, it runs a deficit. To meet additional expenditures, the government needs to borrow domestically or from overseas.

Fiscal policy is therefore the use of government spending, taxation and transfer payments to influence aggregate demand. These are the three tools inside the fiscal policy toolkit.

Main Objectives of Fiscal Policy:

a). Economic growth: Fiscal policy helps maintain the economy’s growth rate so that certain economic goals can be achieved.

b). Price stability: It controls the price level of the country so that when the inflation is too high, prices can be regulated.

c). Full employment: It aims to achieve full employment, or near full employment, as a tool to recover from low economic activity.

Fiscal Policy During Crisis:

During a recession, the government may employ expansionary fiscal policy by lowering tax rates to increase aggregate demand and fuel economic growth. In the face of mounting inflation and other expansionary symptoms, a government may pursue contractio fiscal policy.

Expansionary Fiscal Policy-

Expansionary fiscal policy increases the level of aggregate demand, through either increases in government spending or reductions in taxes. Expansionary policy can do this by (1) increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; (2) increasing investments by raising after-tax profits through cuts in business taxes; and (3) increasing government purchases through increased spending by the federal government on final goods and services and raising federal grants to state and local governments to increase their expenditures on final goods and services.

Impact of Fiscal Policy During Crisis-

If the government cut income tax, then this will increase the disposable income of consumers and enable them to increase spending. Higher consumption will increase aggregate demand and this should lead to higher economic growth.

Alternatively, if the government increased investment in public work schemes, this government spending would create jobs, increase incomes and lead to greater aggregate demand.

AS-AD Model:

Keynes said expansionary fiscal policy should be used during a recession – when there is unemployment, surplus saving and falling real output. He argued this injection of government spending could stimulate economic activity and get the unemployed resources back into productive use. This enables the economy to recover more quickly than a laissez-faire approach.

Here, we will see that how the expansionary fiscal policy work though the AS-AD model graph .

Expansionary Fiscal Policy. The original equilibrium (E0) represents a recession, occurring at a quantity of output (Y0) below potential GDP. However, a shift of aggregate demand from AD0 to AD1, enacted through an expansionary fiscal policy, can move the economy to a new equilibrium output of E1 at the level of potential GDP which is shown by the LRAS curve. Since the economy was originally producing below potential GDP, any inflationary increase in the price level from P0 to P1 that results should be relatively small.

Now Come on the Question:

I have explained in details all about the fiscal policy and how the government use it during recession. I also also discussed about the objectives and benefit of fiscal policy during recession in details. So, i hope it is sufficient to understand the importance of fiscal policy during recession.

We all know that  A recession is a period of economic contraction, where businesses see less demand and begin to lose money. To cut costs and stem losses, companies begin laying off workers, generating higher levels of unemployment.

If the government cut income tax, then this will increase the disposable income of consumers and enable them to increase spending. Higher consumption will increase aggregate demand and this should lead to higher economic growth. Alternatively, if the government increased investment in public work schemes, this government spending would create jobs, increase incomes and lead to greater aggregate demand.

So, its vital for fighting with the recession and government should not remove it otherwise economy can face more serious issues.

Thank You