Aug 25 2010
The Big “C” – America’s crisis of confidence and the Great Recession
Published by Joe Hauet at 3:48 am under AD/AS Model,Consumer confidence,Consumption,Economic Growth,Fiscal Policy,Investment,Macroeconomics,Recession,Supply-side economics
Over a year has gone by since the 2009 American Recovery and Reinvestment Act (ARRA) was passed and put into action by the Obama Administration. Supporters of the program say that it has been successful, arguing that the economy would be in much worse shape if no stimulus had been introduced at all. In fact, some are arguing that government spending has not been sufficient for a full economic recovery and that more direct government spending is necessary. Economists on the other side argue that the stimulus package has done little for the economy except to delay the inevitable, self correcting forces of the economy needed to pave the road back to recovery. Some actually say that we are in a worse situation now due to the massive increase in government debt which will eventually have to be paid back.
So the question is, are we better off as an economy a year after the stimulus package was introduced? With growth still sluggish and unemployment at 9.5%, many people have begun to question the success of the ARRA. Again, some say the $784 billion was insufficient while others say less regulation and more tax cuts should have been utilized.
In a recent Washington Post article, Neil Irwin argues that the obstacles towards economic growth may not be solved by more stimulus, lower interest rates or tax cuts for corporations. The problem, he claims, is not a lack of funds for investment, but in the uncertainty businesses have in future conditions. He writes:
Corporate profits are soaring. Companies are sitting on billions of dollars of cash. And still, they’ve yet to amp up hiring or make major investments — the missing ingredients for a strong economic recovery. Many Democrats say the economy needs more stimulus. Business lobbyists and their Republican allies say it needs less regulation and lower taxes. But here in the heartland of America, senior executives say neither side’s assessment fits.
They blame their profound caution on their view that U.S. consumers are destined to disappoint for many years. As a result, they say, the economy is unlikely to see the kind of almost unbroken prosperity of the quarter-century that preceded the financial crisis.
With consumers choosing to save or pay off their debts now rather than spend, many businesses find it in their interest to hold off on investments into new capital until consumers begin spending again. With no planned investment and no incentive to hire workers, unemployment stays high and economic growth remains stagnant. With inflation rates low and economists predicting deflation, it makes more sense to hold onto money as it is not losing its value.
So is there a solution? In this situation, expansionary monetary policy through lower interest rates will not have the desired effect as demand for loanable funds is low. As stated in the article:
For large companies such as Illinois Tool Works, the price of borrowed money isn’t the problem. The company had $1.3 billion in cash on its balance sheet at the end of June, up from $743 million at the end of 2008. Lower interest rates wouldn’t make much of a difference, either.
“I could borrow $2 billion tomorrow for 3 1/2 percent,” said Speer. “But what am I going to do with it?””
Other executives claim that an increase in government spending would only provide a temporary fix but have no effect on long term consumer spending.
David Speer is chief executive of the company, which has 60,000 employees worldwide in more than 800 business units and $14 billion in sales. He said an additional burst of fiscal stimulus from Washington might help boost economic growth for a period of months. But that is unlikely to affect his decisions about hiring and expansion, which Speer said are based on expectations for sales over years to come, not just the immediate future. As long as U.S. consumers remain deeply strained, he is unlikely to undertake aggressive expansion.
More fiscal stimulus “might help make things a little better for a couple of quarters, but I’m not sure it would get at the underlying economic issue,” Speer said. “The core question is: How do you get consumers back on their feet. We need growth in a sustainable way, not another Band-Aid.”
Another solution would be for the government to implement supply side measures such as less market regulation and lower corporate taxes. Again, without the much needed consumer spending and confidence, its difficult to say whether or not this will materialize into increased investment and employment.
The rest of the Washington Post article can be read here. Once you’ve read the article, answer discuss the questions below and share your thoughts in a comment on this post.
Discussion Questions:
- Why is consumer spending and confidence so important for businesses?
- What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
- Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
- If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
About the author: Raised in Japan, Joe was an international school student throughout his school years. He studied government and religion at William and Mary, and later economics at UNC Asheville. He has taught in North Carolina, Hong Kong and Switzerland. Joe now teaches AP and IB Economics at Zurich International School. Read more posts by this authorRelated posts:
- It may not be a recession, but it sure feels like one…
- The Great Economic Experiment – for all year 2 IB Econ students
- A must read for AP Macro teachers: Paul Krugman explains why deficit spending during a recession does NOT cause crowding-out
- U.S. Financial Crisis!! What Is Really Happening?
- Too much debt or not enough demand? A summary of the debate over America’s fiscal future
1) As consumers gain more confidence about the future economic situation, they will, in turn, spend more and buy more products from various businesses. This increases business revenue, which then increases THEIR confidence leading to an increase in capital investments and further enhancing the economic situation.
2) Business investments are exactly what the I in the GDP Formula stands for. GDP = C+I+G+(X-M). If businesses increase their investment spending, this increases the overall GDP. As more and more businesses invest after consumer confidence has risen and their spending increases, GDP rises accordingly to the response of consumer spending and business investments. A double whammy. As GDP goes up, the economy also becomes more well off than it previously was.
3) In these current economic conditions, saving up is the first thing that comes to a consumer's mind. Paying off their debts, however, might not be the most favorable choice. After ARRA, the supply of loanable funds shrunk and drove up interest rates into unfavorable territory. Granted, I'm certain not everyone has some kind of adjustable interest rate of some sort on their loans or credit cards, but to those that DO have an adjustable interest rate, paying off ALL of their debt in the current economic situation would just mean they would be spending 'X'% more rather than just sitting it out, paying slightly over the minimum payment. However, all this saving leads to less business revenue. Since consumers are spending less, businesses are not making as much as they would like. Less consumer purchases = Less business revenue= Less business investments = Lower GDP = Worse off economic state.
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The Big “C” – America’s crisis of confidence and the Great Recession
This essay is discuss a topic are America better off as an economy a year after the stimulus package was introduced? Since the 2009 American Recovery and Reinvestment Act (ARRA) was passed and put into action by the Obama Administration.
There is four points of view: the first one is that government spending has not been sufficient for a full economic recovery and that more direct government spending is necessary; the second point of view is that the stimulus package has done little for the economy except to delay the inevitable; the third point is that it has been successful, arguing that the economy would be in much worse shape; the forth point is that American are in a worse situation now due to the massive increase in government debt which will eventually have to be paid back.
Consumer spending and confidence is mention several times in this essay given that it’s very important for business. The reason why it’s so important is for the reason if consumers become confident about the future of American, the will spend their money instead of saving them in the bank. If the demand growing up, it will bring up the confident of the business, if their positive about their future, the more capital investment there will be. What is more capital investment means to the economic, it means the GDP rising. The growing of GDP means a better standard of living means more consumers spending and more business investment.
The consumer choose to pay of their debt, in my point, is not good for the economic.
I agree with the comment by Kevin “Less consumer purchases = Less business revenue= Less business investments = Lower GDP = Worse off economic state.”
I think that the American Recovery and Reinvestment Act is actually good for the economic. In some way, we have to admit that it helps consume, and the GPA is actually growing. Everyone have their own view about the government decision. But a country it’s not like a family or a town. The leader has to make the decision benefit most of the people.
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It is true that the less people purchase, the less businesses make and thus the more people will be hesitant to invest in business. Thus, this situation is bad for the entire economy since the GDP will be lowered.
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1) Why is consumer spending and confidence so important for businesses?
- As consumers gain more confidence about the future economic situation, they will, in turn, spend more and buy more products from various businesses. This increases business revenue, which then increases THEIR confidence leading to an increase in capital investments and further enhancing the economic situation.
2) What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
- If businesses increase their investment spending, this increases the overall GDP. As more and more businesses invest after consumer confidence has risen and their spending increases, GDP rises accordingly to the response of consumer spending and business investments
3) Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
- In these current economic conditions, saving up is the first thing that comes to a consumer's mind. Paying off their debts, however, might not be the most favorable choice. After ARRA, the supply of loanable funds shrunk and drove up interest rates into unfavorable territory. Granted, I'm certain not everyone has some kind of adjustable interest rate of some sort on their loans or credit cards, but to those that DO have an adjustable interest rate, paying off ALL of their debt in the current economic situation would just mean they would be spending 'X'% more rather than just sitting it out, paying slightly over the minimum payment.
4) If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
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I agreed with your comments in regards to this article. It is important if the consumer become confident about the future, and willing to spend their money instead of saving them in the bank.
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Why is consumer spending and confidence so important for businesses?
Consumer spending is the source of businesses' incomes. Consumer confidence determines consumer spendings. While the economy is stagnant, consumers are not going to spend much money on goods and services because they are afraid of losing jobs or having no sources of incomes in the future. Businesses hence have no revenues if consumers do not spend money. Businesses also will delay expansion plans or product development if there is not enough income. Businesses' confidence is closely associated with consumer confidence.
What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
Business investment into capital is a component of GDP in the economy. If businesses don't spend money and don't invest, the aggregate demand will be low. Government generates less revenue. There are less goods and services for the nation to sell abroad, therefore the competitiveness of the market is lowered. If businesses are inactive, the employment rate will remain low, unemployment rate will stay high, and national output will be low.
Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
There is benefit for consumers as they will have money to spend on necessities in the future if the economy remains inactive. It will be wise because the international market is so fickle today and paying off debts and saving leave less worry for tomorrow. The economy crisis started with too much debt, the economy is learning its lesson. However, if the consumers are unwilling to spend, it is very likely that the economy will stay inactive for the long term. It is a vicious cycle.
If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
Fiscal and monetary policies are demand side policy. Government can try supply side policy, such as lowering corporate taxes and deregulation. This gives businesses incentives to hire people. When people are hired, maybe they will be more optimistic on the economy.
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You have rationalized the consumers' behaviours. I agree. It is almost an instinct to save more and pay off more given an uncertain future.
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Why is consumer spending and confidence so important for businesses?
Consumer spending has a domino effect on the rest of the economy. If consumers have more confidence to spend, business will have more profit, and then they will have the confidence to develop and investment more into production.
What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
Increase in investment, increases the GDP of an economy, and this will also increase the aggregate demand because consumers will spend more, and thus this spiral goes up into a recovery.
Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
I believe it is rational at the moment to save and pay off your debts due to the inflation, but considering the high unemployment it can very difficult to do so, so another rational opinion would be not to. But many people feel more secured when they have savings they can fall on later, and also whey they don’t owe anything to anyone.
If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
There are also supply side policies, which include deregulations: this can be the privatization, or increase in competition to boost the economy, financial incentives such as subsidies to allow firms to increase output and education and training to allow more people to get employed and thus raise confidence.
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Hi bhejaichon2, good response to the first three questions, especially the insightful opinion on question 3. However I do wish attempt to answer the last question. I think besides fiscal and monetary policies the government could implement supply-side policies to boost the confidence of consumers and producers and so boost the economy.
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Consumer confidence and spending is essential for the success of businesses. This is because an increase in consumer confidence will increase consumption, and in turn, the revenue of the firms. Therefore, firms will only invest in more factors of production in order to expand the firm if they are confident that the consumer confidence is high, or is predicted to be high in the short term.
Business investment into capital is an essential part of a nation's GDP, and in leading a nation towards economic recovery. This is because as as business investment increases, the circular flow of income through the economy increases simultaneously. This will allow for more employment opportunities, higher incomes, etc; which will increase consumption/living standards, and aid the economy in recovery.
It is rational from the consumers perspective to save and pay off debts at a time of economic crisis rather than to increase in consumption. This is because the consumer confidence is low, and consumers prefer to put-off consumption until a time when they think they will yield a greater return on their consumption.
If supply-side policies such as lower taxes for corporations do not work in aiding the economy to recovery, the government can also implement demand-side policies. These could include a number of policies aimed at increasing Aggregate Demand; which would also provide firms the incentive to invest in capital and aid in economic recovery.
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Consumer spending and confidence is very important for businesses for several reason. First, government spending is not enough for a full economic recovery and that more direct government spending is essential. Second of all, the stimulus package initiated by the government has little influence for the economy except delay the unavoidable. Third of all, if it has been successful, the economy would be in much worse condition. Lastly, massive government debt led Americans in a dire situation, one in which they need to pay back. Consumer confidence is so important because if they are confidence about the future of their country, they will boost the demand. Then, it will bring up the confidence of the business and there will be an increase in capital investment, leading to a rise in GDP. In turn, it will bring about a better standard of living.
When businesses increase their investment spending, it increases the overall GDP. As increasing number of businesses invest due to increased consumer confidence and in turn their spending and business investments. As GDP goes up, the economy also improves.
In the specified economic conditions, putting money aside is a consumer's first priority but paying off their debts may not be the right choice. After ARRA, the supply of loanable funds decrease and spiked up the interest rates into unfavorable terms. If adjustable rates were permitted, to pay off all the debt would mean they are spending more than waiting it out and paying a little over the minimum payment. This type of saving also mean a decrease in business revenue. The lack of consumerism leads to less business revenue, which means a loss of business investments and a decrease in the GDP. All this leads to a worsening of the economic state.
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Why is consumer spending and confidence so important for businesses?
As consumers gain more confidence about the future economic situation, they will, in turn, spend more money, invest, and borrow. This increases business revenue, which then increases THEIR confidence leading to an increase in capital investments and further enhancing the economic situation. This will globally increase AD.
What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
When firms increase their investment spending, this increases the overall GDP. As more and more businesses invest after consumer confidence has risen and their spending increases, GDP rises accordingly to the response of consumer spending and business investments.
Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
It is rational from the consumers perspective to save and pay off debts at a time of economic crisis to save money, rather than spending it. This is because the consumer confidence is low, and consumers prefer to put-off consumption until a time when they think they will yield a greater return on their consumption.
If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
I think besides fiscal and monetary policies the government could implement supply-side policies to boost the confidence of consumers and producers and so boost the economy.
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Hey! i like your your concept of the domino effect, and i like it! It is quite true that if consumers spend because they are confident, creating confidence for business, who will go and invest etc
well done!
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Why is consumer spending and confidence so important for businesses?
Consumer spending and confidence is so important for businesses because consumer determines the consumer spending, which is the biggest source of income for businesses. During an bad economy time or economy crisis, consumers are less likely to spend money on products or services, while in danger of losing their income. If consumer start spending, which increases business revenue, leading to increasing in capital investments. Consumer spending and confidence are closely linked with businesses.
What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
Business basically controls the nations GDP with their investments and spendings. When investment spending increases the overall GDP raises.
Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
The rational thing to do for consumer is to save during the time of crisis rather than paying debts. Because of the consumer spending. At time of crisis, consumer confidence is low, thus increases the act of leaving consumption until consumer confidence rise.
If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
Fiscal and Monetry’s policies are heavy on demand. As the lesson already said, another solution would be for the government to implement supply side measures such as less market regulation and lower corporate tax. Which I think would work as an incentive to increase investments and employment.
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I agree that It is true that a number of policies that are aimed at increasing Aggregate Demand would also work. Good thought.
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Why is consumer spending and confidence so important for businesses?
Consumer spending and confidence is important for a business because they need people to buy their goods and services. With no consumer spending and confidence, there won’t be any products bought. This therefore stops the flow of the economy. Because consumers are not buying the products/services, there is no need for much staff. This is a domino effect that affects everyone.
What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
Business investment is able to create a flow in the economy. When businesses invest it creates a flow of money which is important when leading the economy towards recovery because the money needs to be circulated in order to maintain balance.
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Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
It wouldn’t necessarily benefit the economy for consumers to save and pay off their debts, but it might be to the consumer. To the economy, it would promote spending and therefore a flow in the economy. It might not however be a rational decision as consumer confidence is low during the low economic conditions.
If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
Supply-side policies are what the article suggests. This proposes less market regulation and lower corporate taxes. The article states “Again, without the much needed consumer spending and confidence, its difficult to say whether or not this will materialize into increased investment and employment.”
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I read somewhere in an IB textbook that spending now is better than saving as you can loose your money. In question 3, i agree that consumers should pay off any debts they might have at this time.In addition, it could help the flow of the economy as consumer confidence might rise due to debts being cleared off.
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Hey lzhang2,
I liked your response to the second and third questions in particular, especially how you explained that Business investment is a component of measuring GDP, and therefore affects aggregate demand. Aggregate demand then determines the economic recovery.
Thanks,
lgade2
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Consumer spending and confidence are fundamental to the circulation of income and money in general for an economy. If the consumers are confident in their spending abilities and or habits, they are more likely to purchase more goods and services which is crucial for the businesses and firms marketing them.
Business investment is one of the components of GDP, and therefore increased investment will stimulate the economy by increasing Gross Domestic Product. Once the GDP increases after a recession (decrease) or market crash, economic recovery has begun.
When interest rates are escalating, saving money is an appealing alternative to investing or spending. This indicates a positive result of consumers saving money. However, paying off debts may not be so rational at this time with a high inflation rate. It’s better to pay off the debt after you’ve saved money and inflation has decreased.
Lower taxes allow for a decrease in the costs of production which is often appealing to businesses and firms because they can increase their supply, in hopes of balancing out demand. However, this doesn’t always work and the government may need to increase competition within the market, or turn to the private sector for aid in economic recovery.
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I agree with your possible methods for economic recovery; subsidies can be crucial strategies for government aid, whereas the private sector is important to target too, especially in economies where private companies are plentiful.
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1.Why is consumer spending and confidence so important for businesses?
Businesses rely on the demand for their product, so if aggregate demand is low then the businesses have no reason to expand and become afraid to invest. On the other hand if consumers are confident with the economy, they spend more which boosts business confidence and they invest more, and it‘s an upwards spiral.
2.What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
Business investment is important because it encourages economic growth, and injects money into the economy, and could even lower the unemployment rate because of the unemployment of people to create new buildings etc.
3.Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
There isn‘t much benefit in it, in all actuality it can be harmful if there is deflation because then people can lose some of the purchasing value of their money if they decide to save it. Consumers need to be encourages to spend and increase the circulation of money within the economy, if things continue as they are now the economy will be at a stand still.
4.If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
Supply side policies are always an option, such as deregulation where the government reduces its role and allows greater freedom within the economy, which might result in more competition and privatisation of firms.
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Hi Kevin V. Although you didn't respond to all of the questions, I really enjoyed reading through your post. I think you raised a good point saying that business investments are a component of the GDP formula, it's actually a very concise explanation. I agree, all saving does lead to less business revenue but I think it's good to consider the idea that saving money is basically saving for future expenditure, it's very likely that the money will circulate back into the economy at some point, so it isn't completely lost in the long term, only the short term.
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1) Why is consumer spending and confidence so important for businesses?
Consumer spending is important to firms because they receive revenue through the sale of their products. If consumer confidence is high due to predictions of rises in income for example, then they will spend more money on products produced by businesses, and this will increase the firms profits and give them the incentive to expand production.
2) What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
With increased investment aggregate demand will increase and this will lead to a rise in an economy's
real GDP, ceterius paribus. The increased investment in capital will also cause economic growth as there has been an increase in the quantity of a factor of production which will cause a shift to the LRAS curve to the right.
3) Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
It is not beneficial to the economy for consumers to save and pay off their debts now because this will mean they will spend less worsening the already bad economic climate. Firms will slow down production and lay off workers due to the low demand which will further increase the high unemployment and lower the real GDP. From a consumers perspective it is probably a rational decision to save now and spend more at a later time as the economy is almost experiencing deflation, in which case the more time that passes the more purchasing power consumers will have as prices of goods and services continuously fall.
4) If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
The government can use supply side policies such as deregulation and this is where the government decreases its regulation so as to increase competition and efficiency.
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@kedwards
Paying off debts now would not be so rational because consumers would be making less purchases and this will further reduce the production by firms due to the low demand, this will worsen unemplyoment as less workers are needed and additionally the real GDP will fall. The inflation rate is NOT high, it is actually low and reaching deflation. Other than this I agree with your statements.
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Discussion Questions:
1.Why is consumer spending and confidence so important for businesses?
Consumer spending makes up most of the cycle of the economy and circulation of money between households and firms (business and trade cycle). Confidence is important as when consumer confidence increases, so does their spending and this creates more money going around the economy. Businesses benefit from this as more of their products are bought and that means more income for them.
2.What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
Similar to consumer confidence, when businesses invest into capital, the production increases helping the circulation of money in an economy and when more money is circulation in the economy it will inch its way to recovery.
3.Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
It can be said as the rational thing to do from the consumers’ point of view and decrease consumption (or try to maintain although most people decrease the amount consumed) as vice versa from the above answer, when the economy is not doing to well, consumers are faced with more issues and risks lowering their confidence and this affects the amount they consume.
4.If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
The government could instead implement a supply-side policy by promoting consumer spending through giving consumers more freedom in consumption. As for businesses, this new “freedom” would allow them to be more competitive thus creating better and more innovative and beneficial products.
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Hi axu2,
I agree with your answers. In question 3, it is true that low confidence makes consumers not spend and businesses avoid investments as they do not get as much in return as they would when the economy is doing better. Overall, good answers!
Mirren Mecathum
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1.Why is consumer spending and confidence so important for businesses?
The article discusses the need for investment for economic growth, however businesses need confidence and a level of consumer spending in order to make the decision to invest. With low consumer spending, the firm has no room for growth, because people are not willing to purchase additional products – this means there is no incentive for the firm to increase production, and so no reason for investment. As well, firms are wary to invest when the future of the economy remains uncertain, because it is a large risk that they are not willing to take. Firms have the money to invest, that is not the problem – the problem is they do not have the need or desire to invest at this time, and that is why economic growth cannot occur.
2.What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
Investment is a component of aggregate demand, and it results in an injection in the economy, allowing it to grow. By investing into capital, firms allow increased production to occur, making economic growth possible, and only by expanding and growing they are able to help the economy recover.
3.Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic decisions?
By paying off debts now, consumers can ensure greater stability and security in their financial situation. Without large debts, they can be more confident in knowing that they have financial security, and so will be more willing to spend in the future. Since the economy is uncertain, there is risk going into the future, and so it is rational for people to be saving, under the prediction that the economy may not fully recover, but rather get worse. This means that, if things do get worse, they won’t be in the worst situation with everything to lose, but rather will have some sense of safety.
4.If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
Well firstly, if it was possible for us to determine what the answer to America’s economic crisis was (when the government could not get it right), we would be very valuable! However – supply side policies are another option for the government, which would increase competitiveness and allow greater freedom in the economy, potentially leading to more growth. One argument made by some economists, though, is that the economy must be allowed to go through its cycle and self-correct, which might mean things get worse before they get better…
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Hi nvirani2,
I like the comparison you made with the economic situation and a domino effect! You bring up a very good point that highlights the fact that every aspect of the economy is dependent on another – in order for economic growth to occur, consumers need to spend, so that firms can invest, so that they can hire more workers, who can in turn spend… Its definitely important to recognize that it is a cycle and disrupting one aspect will come to affect the whole. Thanks!
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1.Why is consumer spending and confidence so important for businesses?
As consumers gain confidence, they will become more optimistic about the future of the economy. They will start spending and this is what will trigger businesses to invest. Firms will also have an increase in revenue as consumers begin to invest and spend more and their business confidence will then increase too.
2.What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
Just increasing one component of AD, government spending is not enough to move the economy out of recession. As businesses invest, there is an inflow of money into the economy, it will increase the total GDP. It will also cause consumers to start spending and this increase in consumption, investment and government expenditure will cause the AD to increase and thereby lead the economy towards recovery.
3.Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
I think this would be the first thing that the consumers want to do but in my opinion, it is not good for the economy because it shows that they are not confident about the economy in the long-run and it will only cause a further recession.
4.If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
One of the biggest consequences of this economic downfall is the high unemployment rates, therefore the government could possible intervene through interventionist supply side policies.
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Hey sophie zhou,
I enjoyed reading out post and I thought you really understood what you were talking about. On the 3rd question, I liked how you explained the negative impacts on the economy from consumers choosing to pay off their debts.
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1.Why is consumer spending and confidence so important for businesses?
Consumer confidence and spending determines the level of demand, and the level of demand is important for aggregate supply. This is extremely important for businesses because it determines how much they invest in order to grow as a business. If consumer spending is low along with the confidence, there is nothing to say that the investment into creating more and better quality products will pay off, thus the businesses do not have incentive to grow and develop, which is the ultimate goal. Whereas if consumer spending is increasing, there will be increased profits that the business will be able to put to use for expansion.
2.What role does business investment into capital play in the economy and why is it so important in leading the economy towards recovery?
In the circular flow of demand, investments are injections, which is essential for a recovery (versus leakages). With investment into capital, business will be able to expand their production, and this will stimulate economic recovery and growth.
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3. Is there any benefit in the economy for consumers to save and pay off their debts now? Is this a rational decision given the current economic conditions?
There are benefits to paying off debts first. Paying off, and getting rid of debt, will make consumers more confident to spend in the future because with no debt, they will feel more financially stable. Once everyone feels this way, the economy can begin to recover because with increased confidence there will be increased spending, and the AD, AS, national level of output will all start to climb once again. Thus, it is a rational decision to pay off debts first and gain that financial stability.
4. If fiscal and monetary policies along with lower taxes for corporations are not the answer, then what is? What other possibilities are available for the government to implement?
Firstly, it may not be the question of fiscal or monetary policies, but rather that the economy goes through natural slumps and booms, so the economy will naturally return to its fullest while going through the cycle. However another thing that can be done is instead of demand side policies, the government can implement supply side policies in order to stimulate economic recovery.
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Hey dnyanzi
Great response! However in question 3, you replied that paying of debts now would worsen the already bad economic times becasue consumers would spend even less…however, if consumers are all experiencing debt, this mean that they are financially unstable, and this instability and uncertainty might cause even further decrease in consumer confidence, therefore it will take longer for spending to increase, becasue the pressure of debt makes people want to spend less….just a thought
Nadiya
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