#596 The text describes several fiscal policies

The text describes several fiscal policies - Economics

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The text describes several fiscal policy options to stabilize the economy: Changes in Government Purchases, Business Taxes, Income Taxes, and Transfer Payments. Based on what you’ve learned so far in the course, determine if the country you are living in currently needs economic stimulus or contraction. Describe how each policy option could specifically be used to change the national economy. Example: Country Z needs economic stimulus. The government could lower the business tax on buying new equipment. This would stimulate the economy because firms would have more money to invest, which, in turn, increases demand in the equipment supply sector. I live in South Africa, Please use the South African economy.

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For the United States, the mounting debt-GDP ratio and rising unemployment calls for a fiscal expansion. The government will have to adopt an expansionary fiscal policy of reducing income taxes, corporate taxes, increase investment tax credit, increase government spending, increase transfer payments, to give the required boost.

An investment tax credit would stimulate investment spending as it would increase the real interest rate that is available on an investment after the tax is paid. This would shift the supply of loanable funds to the right and decrease the interest rate so that investment rises.

The market for loanable funds is shown in figure B. Supply of funds is determined by the saving function which is here fixed. Demand for loanable funds is determined by the demand for investment from both purposes: residential and business.

A policy of investment tax credit on business investment does not affect residential investment. But it encourages business investment. Hence it shifts upwards. With this total investment shift out. In the short run, the market from loanable funds has excess demand as it moves from point A to point B.

With time interest rate rises from v1 to v2 thus moving the economy from point B to point c. Higher interest rates discourage both types of investment.

Fiscal expansion

Under the fiscal expansion, the government can increase its spending which will increase aggregate demand AD. Hence, there is a new equilibrium in the goods market with higher output and price level. IS shifts to the right. Believing that there is no crowding out there is higher investment demand, so interest rate rises on one side and income on the other. The figure below illustrates this graphically, since the income has increased initially, this has increased consumption which increases income again through multiplier effects.