Question

The US decided to spend it's way out of the recession and England decided to cut spending. Compare and contrast the two ways to deal with the recession: austerity or spending, reducing interest rates and QE. Has there been a difference in GDP growth?

Answer 1

The basic features of recession are low real GDP, low investment, higher unemployment, increased government borrowing and lower price level. The basic reason of recession is fall in aggregate demand. Thus every government is expected to raise aggregate demand by rising consumption, investment and net export. The government can use its fiscal and monetary measures to raise aggregate demand and remove recession.

During recession the government can resort to increased public spending and reduction in tax rate. The increase public expenditure increases the income of the people which create more consumption demand. The increased demand generates more investment in private sector. This will further increase employment and the growth rate of GDP. Thus an initial increase in government spending generates income and employment in multiple forms.

The decision of U S government to increase its expenditure is a wise policy. The increased spending increase employment and income level and finally stimulate economic growth rate.

But the policy of England to cut government spending is unwise since it aggravates unemployment and generate lower growth rate. During recession what the economy actually needed is stimulate aggregate demand. During recession the private investors do not come forward to invest in productive channels due to low price a and profit. Thus it is the responsibility of the government to increase its spending so as to remove the deficiency in aggregate demand. So if the government in England decided to cut expenditure, the magnitude of recession expanded and the economy will further fall in to wild depression. For example a decreased public spending during times of recession reduce the income of people which further dampen the aggregate demand. The increased reduction in aggregate demand further lowers nation oupuput and employment. The economy will register lower growth rate.

The government can also use its monetary policy against recession. The proposed monetary policies are cutting interest rate and quantitative easing. The central bank can reduce the interest rate through a bank rate, and discount rate policy and can increase money supply buy buying securities from the open market. The quantitative easing increase the bank reserves and promote more lending from the bank. The increased money supply through quantitative easing and lower bank rate and discount rate both lowers the rate of interest. This fall in interest rate create more consumer demand and investment demand. Again the fall in domestic interest rate increase the net export through depreciation in currency value. All these increase aggregate output, income and employment and a higher growth rate.

There will be a difference in GDP growth rate between the countries which increase the public expenditure and decrease the public expenditure during recession. The growth rate will be increase in countries which increase it expenditure during recession. But the growth rate will further decrease in countries which decrease its expenditure during recession.