Jan 31 2008
Alice Su, an AP Econ student, asked a very good question in class today during our discussion of the business cycle, which illustrates the tendency of national economies to fluctuate between periods of expansion and recession. Karen wanted to know what a government could possibly do to try and avoid the dismal prospect of repeated recessions on and on into the future that the business cycle seems to suggest is the fate of any economy.
To answer Alice’s question, we can look at the United States right now, where the Bush administration and the Democratic led Congress have teamed up to approve a fiscal stimulus package aimed at boosting consumer spending and business investment, thus putting the economy back on the path of expansion and economic growth.
A government can only try to stimulate aggregate demand and/or aggregate supply in times of recession. The tools at the government’s disposal include changing tax policies and increasing or decreasing government spending. In times of recession, tax cuts should encourage businesses and households to spend more, increasing GDP. Likewise, new government spending increases GDP directly. The current stimulus package approved by the White House and Congress focuses on the tax side. Listen to the excerpt from a recent episode of WBUR Boston’s OnPoint radio show.
Tax rebates (which will appear as checks in the mail to most households earning under $75,000 per individual or $150,000 per working couple) will increase households’ disposable income. More disposable income should increase the overall level of consumption by households (and investment by firms who also will receive rebates), stimulating new spending and shifting the economy towards a recovery. Under Congress’s plan the government will issue tax rebates of up to $600 for working individuals, $1200 for working couples, plus $300 for each child.
Missing from Congress’s plan, however, are increases in government spending. It is not uncommon for stimulus packages to include both tax cuts and new government spending.
How would changes in government spending affect overall output (and thus income) in the economy? The columnist in the podcast makes a couple of suggestions that may have contributed to the stimulus resulting from the $146 billion tax rebate. He says the government should consider, “extending unemployment benefits or increasing food stamp spending”.
The White House’s bill, however, included no such increases in spending. In the podcast, the columnist explains the absence of new government spending: “If you increase spending on a temporary basis, you can’t undue it, because you can be accused of being harsh, because you’re going to cut food stamps in the future.” In other words, the tax rebate is a one time shot; everyone gets a check in the mail and everyone’s happy. Increased spending on welfare and unemployment benefits, while enjoyed by those suffering from the economic slowdown, will be politically almost impossible to roll back once the economy is in better shape. (For those of you in my class, this should remind you of the “mommy” vs. “daddy” conversation we had today!)
Should the stimulus package have gone further? In addition to tax cuts, should Congress be extending a helping hand to workers and families who suffer from the economic downturn?
The tax rebate “stimulates short-term spending”. Is it enough to put America back on the expansionary path of its business cycle?
These are tough questions, although most economists tend to believe that a rebate equal to around 1% of total GDP is far from enough to assure a solid recovery. This may not be the government’s intention, however. What the government is trying to do is “avoid a vicious cycle where bad news begets more bad news… if you can avoid that then in the long run we’re a lot better off.” The “vicious” cycle the columnist refers to is, of course, the business cycle.
Perhaps Congress knows from history that business cycles are unavoidable, and the current stimulus package is not meant to propel the US economy to new heights of economic growth, rather to slightly offset the negative effects of a recession that may in fact be an unavoidable side effect of our ever-fluctuating economy.
Or, as the columnist says, “Why put more medicine in now than is necessary?” What do you think? Should the government put more medicine in than the seemingly minuscule dosage equaling merely 1% of GDP?
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