Fiscal Policy: Please Respond To The Following Which Fiscal

Fiscal Policyplease Respond To The Followingwhich Fiscal Policy Mea

"Fiscal Policy" Please respond to the following: Which fiscal policy measure is more likely to have a greater impact on the economy when unemployment is rising and consumer confidence is falling - an increase in government spending or an equal decrease in taxes? Explain your reasoning. Optional: Assuming, in a simple economy with no net exports, the marginal propensity to consume (MPC) is 0.8. This would generate a government spending multiplier of 5.0 and a tax multiplier of -4.0. If government spending increased by $100 million, what would the impact be on total spending in the economy? If instead, taxes were reduced by the same amount, $100 million, what would be the impact on total spending in the economy? Could the government run a balanced budget (increasing government spending and taxes by the same amount) and still grow the economy?

Paper For Above instruction

Fiscal policy plays a crucial role in managing economic fluctuations, especially during periods of rising unemployment and declining consumer confidence. When the economy faces such downturns, policymakers primarily rely on expansionary fiscal measures to stimulate economic activity. Two principal tools in this approach are increasing government spending and decreasing taxes. Understanding the relative impacts of these measures is essential for effective policy formulation.

When unemployment is rising and consumer confidence is falling, an increase in government spending generally has a more immediate and potent influence on economic growth than an equivalent tax cut. This effectiveness is grounded in Keynesian economic theory, which emphasizes the role of government expenditure in boosting aggregate demand. Increased government spending directly injects funds into the economy by creating jobs, financing infrastructure projects, or expanding social services. These expenditures tend to be more predictable and immediate in their effects because they involve direct government activity, which quickly stimulates demand in various sectors.

Conversely, tax cuts leave more discretion to households and firms regarding how to allocate additional disposable income. If consumer confidence is low, consumers are more likely to save additional income from tax cuts rather than spend it, diminishing the immediate stimulative impact. Moreover, when consumer confidence and expectations are negative, households tend to increase savings or pay down debt rather than increase consumption, weakening the multiplier effect of tax reductions.

This difference in effectiveness is reflected in the economic multipliers associated with each policy instrument. Government spending has a higher multiplier effect because each dollar spent by the government catalyzes further spending throughout the economy—this is often referred to as the government spending multiplier. In contrast, tax cuts have a lower multiplier since part of the tax relief may be saved rather than spent, especially in uncertain times. Therefore, during periods of economic downturn marked by rising unemployment and falling consumer confidence, increasing government expenditure is Generally more effective in boosting aggregate demand quickly and significantly.

In the context of the specific economic parameters provided, the impact of fiscal policy actions can be quantified. With a marginal propensity to consume (MPC) of 0.8, the government spending multiplier is calculated as 1 / (1 - MPC), which yields 5.0. The tax multiplier is computed as - (MPC / (1 - MPC)), resulting in -4.0. These multipliers indicate that a $100 million increase in government spending will generate a total increase in overall spending of about $500 million (5 times the initial expenditure). This is because the government’s initial expenditure circulates through the economy, sparking additional demand at multiple levels.

On the other hand, a $100 million decrease in taxes would lead to a total increase in spending of approximately $400 million (the tax multiplier of -4 multiplied by the change in taxes). The reduction in taxes leaves households with more disposable income, which, depending on their propensity to consume, leads to increased consumption and economic activity.

The question of whether the government can run a balanced budget and still foster economic growth hinges on the interplay between government spending and taxation. If the government increases both spending and taxes by the same amount, the net effect on aggregate demand depends on the relative size of the multipliers. Since the government spending multiplier (5.0) exceeds the absolute value of the tax multiplier (4.0), increasing both by the same amount can result in a net positive impact on total spending, thus promoting economic growth even without a budget deficit. This aligns with the Keynesian perspective that fiscal policy can be expansionary in a balanced budget scenario when the government’s expenditures trigger a larger multiplier effect than the contractionary effect of increased taxes.

In conclusion, during times of economic downturn characterized by rising unemployment and low consumer confidence, increasing government spending tends to yield more immediate and substantial stimulation of aggregate demand than an equivalent tax cut. Nonetheless, both tools are valuable in fiscal policy, and their combined use—appropriately calibrated—can effectively sustain economic growth without necessarily increasing the deficit. The specific multipliers highlight the potency of government expenditure in amplifying economic activity, but policymakers must consider the broader fiscal sustainability and long-term impacts of such measures.

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