Question

1. What will counter cyclical budgeting policy?

2. What types of government policies would counter the business cycle. What types of policies should government implement if economy is in severe recession.

Answer 1

1. What will counter cyclical budgeting policy?

Counter cyclical' budgeting policy takes the opposite approach: reducing versus spending and raising taxes during a boom period, and increasing spending and cutting taxes during a recession. Conversely, economic or financial policy is called countercyclical if it works against the cyclical tendencies in the economy. That is, countercyclical policies are ones that cool down the economy when it is in an upswing and stimulate the economy when it is in a downturn.

Keynesian economics advocates the use of automatic and discretionary countercyclical policies to lessen the impact of the business cycle. One example of an automatically countercyclical fiscal policy is progressive taxation. By taking a larger proportion of income when the economy expands, a progressive tax tends to decrease demand when the economy is booming, thus reining in the boom. Other schools of economic thought, such as new classical macroeconomics, hold that countercyclical policies may be counterproductive or destabilizing, and therefore favor a laissez-faire fiscal policy as a better method for maintaining an overall robust economy. When the government adopts a countercyclical fiscal policy in response to a threat of recession the government might increase infrastructure spending.

In business cycle theory and finance, any economic quantity that is positively correlated with the overall state of the economy is said to be procyclical. That is, any quantity that tends to increase in expansion and tend to decrease in a recession is classified as procyclical. Gross Domestic Product (GDP) is an example of a procyclical economic indicator. Many stock prices are also procyclical because they tend to increase when the economy is growing quickly.

A concept is often encountered in the context of a government's approach to spending and taxation. A 'procyclical fiscal policy ' can be summarised simply as governments choosing to increase government spending and reduce taxes during an economic boom, but reduce spending and increase taxes during a recession. A 'countercyclical' fiscal policy takes the opposite approach: reducing spending and raising taxes during a boom period, and increasing spending and cutting taxes during a recession.

2. What types of government policies would counter the business cycle. What types of policies should government implement if economy is in severe recession?

Procyclical and countercyclical variables are variables that fluctuate in a way that is positively or negatively correlated with fluctuations in the gross domestic product (GDP). The scope of the concept may differ between the context of business cycle theory and that of economic policymaking.

The annual budget format as an achievement of the budgetary reform movement has served state and local governments well for a century by tightening control over spending and strengthening day-to-day financial management. But its one-year span renders it an inadequate tool for financial planning, resulting in cyclical deficits that are insurmountable with the mechanisms available in the traditional budgetary system. As a consequence, state and local governments often have to adopt procyclical fiscal measures in recession years, a fact illustrated during the 2001 recession by hiring freezes, reductions in services, and higher taxes. The multiyear budget format looks appealing as a way to restore the tripod of the modern budgetary system, but this format is dependent on accurate estimates of revenues and expenditures in the coming years. On one hand, economic forecasts are very resource- intensive (in terms of expertise, time, and equipment), but on the other hand, the inherent uncertainty of economic activity and the complexity of forecasting make technical errors unavoidable (and other technical details are yet to be worked out), creating a barrier to wider adoption of multiyear budgets. This is a conundrum facing contemporary public budgeting. The theory of subnational countercyclical fiscal policy offers a possible solution. By adopting such a fiscal policy and using effective policy tools, state and local governments can mitigate the adverse effects of forecasting errors, narrow expenditure gaps in recession years, and maintain fiscal stability over the business cycle. At the state level, the policy tool of choice used to be general fund surpluses; since the late 1970s, the budget stabilization fund has enjoyed increasing appeal. Enabling legislation is a prerequisite for creating budget stabilization funds at the state level. The BSF legislation does much more than creating a countercyclical reserve; it institutionalizes countercyclical fiscal policy, lifting the policy to a level above and beyond the whimsical power of single political actor.

The policy becomes a permanent feature of the government system. This, in the language of institutionalism, is capacity building. With a well-structured, institutionalized BSF, a state can accumulate high levels of fiscal reserves, which turns the potential countercyclical capacity into actual fiscal capacity — and with a higher level of fiscal reserves, a state can better manage public expenditures to deliver services during recessions. This link transforms management capacity into performance.

Multiyear budgeting without countercyclical fiscal policy is an unreliable journey. Multiyear budgeting coupled with countercyclical fiscal policy and an appropriate policy tool stresses financial planning and provides a firewall against unexpected events. With such a policy and policy tools, state and local governments can respond positively to expansionary monetary and fiscal policies at the national level. This couplet is budgeting for fiscal stability over the business cycle by state and local governments. It is my belief and hope that equipped as such, state and local governments will be able to better withstand the economic fluctuations of the future.