The role of fiscal policy in stabilizing economy in US

Definition of fiscal policies Fiscal policy is the setting of the level of government spending and taxation by government policymakers.. Meaning of stabilizer of the economy According t

Topic 12: Fiscal policy is considered to be important tools and known as stabilizer for economy Study the role of fiscal in stabilizing economy in us

Fiscal policy is considered to be a very important tools known as stabilizer for the economy It is used by government to mitigate adverse effects of growing too fast as well as negative economic growth

I Literature review

1 Definition of fiscal policies

Fiscal policy is the setting of the level of government spending and taxation by

government policymakers

2 Meaning of stabilizer of the economy

According to Keynesian economics, when the government changes the levels of taxation and governments spending, it influences aggregate demand and the level of economic activity Fiscal policy can be used to stabilize the economy over the course

of the business cycle

The two main instruments of fiscal policy are changes in the level, composition of taxation, and government spending in various sectors These changes can affect the following macroeconomic variables, amongst others, in an economy:

- Aggregate demand and the level of economic activity;

- Savings and Investment in the economy

- The distribution of income

There are there fiscal policies: expansionary fiscal policy, contractionary fiscal policy

- In a depression: The real output is smaller than potential output and high inflation rate In this case, government should apply expansionary fiscal policy by increasing G and/or decrease T It leads to an increase in aggregate demand and output, a decrease

in unemployment rate

- In the economy with a high inlation rate, actual output exceeds potential output, government should apply contractionary fiscal policy by decreasing G and/or increase

1

T It leads to a decrease in aggregate demand, otput and inflation rate but an increase

in uneployment rate probably

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For detail, when actual output (Y) is larger or smaller than potential output (Yp), the leaders must adjust to increase or decrease T, G and figure out the elements to effect the sustainable economic equilibrium We call it: ∆Y (∆Y= Yp –Y )

- If government spending is the only tool used in fiscal policy:

So, government spending need to be adjusted: ( m: the multiple)

- If tax is the only tool used in fiscal policy:

So, tax need to be adjusted :

- If both G and T are used in fiscal policy:

So, both G and T need to be adjusted:

- The investment regression analysis: when government spending increases or tax

decreses, GNP (Gross National Product) will rise sharply, which leads to an increase in money demand Given money supply, a growth in interest makes a decline im

imvestment As a result, GNP decreases because of a deep deficit which follows by an investment regression Therefore, the effficiency of fiscal poilicy decrease

3 Important roles of fiscal policy

- Fiscal policy aims to remain balanced budget: in this policy, government always

reaches the balanced budget whatever levels of output are:

- Y<Yp

- ui>un

- B<0 (G>T)

- G, T no changes

- G, T

- G no changes, T

AD Y , u , P

In a recession, a balanced budget is unstable because

Q, T budget would be deficit in the future

- Y>Yp

- ui<un

- B>0 (G<T)

- G, T no changes

- G, T

- G no changes, T

AD Y , u , P Therefore, in the long-run, budget will be balnaced but high inflation

(B= - G + t.Yp)

- Fiscal policy aims to remain long-run level of output: In this policy, government wants

to keep the economy at the potential output and sufficient employment

- Qa<Qp

- ui>un

- B<0 (G>T)

- G, T no changes

- G, T

- G no changes, T

AD Q , u , P

So, recession is avoided but budget is in deficit, therefore solutions for sponsoring the budget deficit are needed

- Y>Yp

- ui<un

- B>0 (G<T)

- G, T no changes

- G, T

- G no changes, T

AD Y , u , P

So, the short-run inflation is avoided but the budget is in surplus and the economy is

in deficit

As we mentioned before, fiscal policy with two effective tools tax and government spending has important roles on stabilizing of the economy, tends to move the economy toward full employment, encourage economic growth or control inflation The stabilization fuction include promote sustained economic growth, low unemployment rate and price stability It is expressed by

- To organize resources: The top aim of fiscal policy in many counttries is to organize resources on private and public sectors The government of many conutries through obligatory savings pushes the rate of investment and capital establishment which in promotes of economic development

- To accelerate the rate of economic growth: fiscal policy helps to accelerate the rate

of economic growth by raising the rate of investment in public as well as private sectors Therefore, various tools of fiscal policy as taxation, public borrowing, deficit financing and surpluses of public enterprises should be used in combined manner so that they will not adversely affect the consuption, production and distribution of weath

- To encourage socially optimal investment: In underdeveloped and developing coutries, fiscal policy encourages the investment into those productive channels which are considered socially and economically desirable This means optimal investment which promotes economic development and avoids wasteful and unproductive investment

- Persuasion to investment and capital formation

- To provide more employment opptortunities

- To promote the stabilization of economy

- To check trend of inflation

- To distribute properly national income

4 Drawbacks of fiscal policy

- Government does not know the value of the core constraints (MPC, MPS, MPM, …) therefore, it is diffcult to determine the multiplier, which leads to mistakes in

enforcement monetary

- Fiscal policy contains time delay because of some reasons such as the amount of time collecting data, processing data, making decision and the time between

implementing policies until it take effect

- Expansionary fiscal policy is easy to apply while there are many diffculties in applying contractionary ploicy because in this case, government increase tax and cut spending at the same time, which leads to instability in the economy

- Fiscal policy can be applied only in serval project, employment development and subsidy programs

II Fiscal Policies in US

1 Fiscal policies in booming period

In business dictionary, booming period of economy (or can also called economic expansions) is a period of significant output within a population The period is marked

by productivity increases, sales increases, wage increases and rising demand It also is

a period of economic growth as measured by a rise in real GDP

* In the period 1982-1990 (lasts 92 months)

It is the second longest peacetime economic expansions after the oil crisis in1973 and the energy crisis in 1979 with the great inflation In the early 1980s, together with the tax cuts, Reagan – president of The United State - also significantly reduced social programs During his tenure, Reagan also conducted a campaign to reduce or eliminate the activities of government regulatory impact on consumers, jobs and the environment However, at the same time, he feared that the United States was indifferent to his troops after the Vietnam War should have boosted defense spending The combination of tax cuts and defense spending boost would overwhelm reducing the level of spending for domestic programs The result is the federal budget deficit increasing outpacing even economic times the severe slump early 1980 from $

74 billion in 1980, the federal budget deficit rose to USD 221 billion in 1986 it fell to

$ 150 billion in 1987, but then began to increase again Some economists worry that the spending and borrowing too much federal government could fuel inflation, but the Federal Reserve remains wary of the escalating price controls, maneuver quickly to raise interest rates any time feel threatened Federal Reserve Board Chairman Paul Volcker under and his successor, Alan Greenspan, has kept the central role of economic traffic cop, dominate both parliament and the president of the national

* In the period 1991-2001 (lasts 120 months)

For over 9 years (1991-2000), US economic growth, continuous and stable at 2-4% and reached a record 5.2% in 2000 For the first time since 1969, America had a budget surplus and maintain for 3 consecutive years (1998-2000), the highest reaching

237 billion USD in 2000 The inflation rate is low, an average of 2% / year (10 years ago is 3.7 %) The lowest unemployment rate, average 5.3% in 10 years In just 10 years, labor productivity doubled, from 1.5% / year to 3% / year.By the end of 1999,

the US economy has grown continuously since March 1991, following a period of economic growth in the longest peacetime in American history November 1999, the total number of unemployed people accounted for only 4.1% of the labor force, the lowest rate in nearly 30 years And consumer goods prices, rose only 1.6% in 1998 (the lowest rate except for one year since 1964), increased only slightly in 1999 (2.4%

as of October) There are still many challenges ahead, but this nation has overcome the twentieth century - the tremendous upheaval of this century - in a state of fitness But since Bush took office, the US economy began to stagnate and difficult, especially since the events 11/9/2001 The growth rate in 2002 was 2.2% (2001 1.1%), high unemployment (5.9%); trade deficit at a record high (about 420 billion US dollars, up 17% compared to 2001); budget deficit of 159 billion dollars due to large tax cuts program (1350 billion dollars in the 11 years from 2002)

The financial policy monetary easing to restore and promote economic growth have been made:

(1) maintain the lowest interest rates in 50 years (1%);

(2) increasing public investment, especially in defense spending;

(3) reduce the dollar prices to promote exports;

(4) the state of twin deficits (balance of trade and budget)

* In the period 2009-2010

For the whole of 2010, the total gross domestic product (GDP) of the economy of the world increased by 2.9% 1, as opposed to the 2.6% decline in 2009 and to 0% in

2008, while the the strongest growth since 2005, while GDP grew by 3.1% Thus, US GDP has grown for six consecutive quarters after experiencing the longest period of crisis and deepest since the 1930s

Economic analysts predict this year, the US economy could grow 3 to 3.6% because of the economic stimulus programs, from the performance of tax cuts for two years worth of 858 billion dollars that Congress passed last year, to the continued implementation of the program of the Federal reserve Bank (Fed) to buy long-term bonds worth 600 billion USD

2 Fiscal policies in crisis

Crisis economic is a situation in which the economy of a country experiences a sudden downturn brought on by a financial crisis An economy facing an economic crisis will most likely experience a falling GDP, a drying up of liquidity and

rising/falling prices due to inflation/deflation An economic crisis can take the form of a recession or a depression

In the period 1929-1933

Crisis 1929 - 1933 was a great depression with the largest scale, the most severe level of the capitalist world It is a structural crisis, Americans referred to it as a horror, the pain Meanwhile the US is the most developed capitalist countries, but the

distribution system of American society at that very unjust, national income largely concentrated in the hands of a few people, profit increased from 1922 - 1929 as 76% of the wages of workers increased by only 33% and employees 42% Meanwhile, the profits of the shareholders increased over 100% Workers do not enjoy their rightful share in the index of the economy increased All lead to a crisis of overproduction, leading to the phenomenon of the small and medium capitalists mass bankruptcy, they hand out the plant, sinking ships and wealth poured into the sea to keep price

Until the beginning of the Second World War, when the US government to apply Keynesian economic theory with the main focus is to highlight the role wage growth (to increase aggregate demand) and the role of the state in the management of the economy, the new economy recovers

Production output doubled during the war, unemployment disappeared when women and blacks are called to participate in the labor force instead of millions of people were involved in the military At its height, the US government was borrowing half the

money needed to have the money to pay for the war

In the period 2007–2009

This crisis is the main reason for the US economy into recession since December

2007 NBER (National Bureau of Economic Research) predict this will be the most severe recession in the United States since the Second World War On average, each month from January to September 2008, there are 84 thousand US workers lost jobs

A series of financial institutions including the giant financial institutions and

bankrupt long pushed the US economy into a credit hunger In turn, the credit hunger

affecting the manufacturing sector that now have to downscale production, laid off workers, cut input import contracts Rising unemployment negatively impact earnings and thereby to consumption of households to make the now hard to sell the goods Many businesses go bankrupt or are at risk of bankruptcy, including three automobile manufacturers of the United States is leading General Motors, Ford Motor and Chrysler LLC The leaders 3 carmaker has instigation Congressional relief, but without success Monday December 12, 2008, GM had announced a temporary closure of its 20 factories

in North America Reduce consumption, redundant power and industrial goods led to the general price level of the economy falling steadily, pushing the US economy may be

a risk of deflation

The crisis also makes the US dollar rose Because the US dollar is the common means of payment in the world today, so global investors bought dollars to improve its liquidity, the US dollar pushed up prices This makes US exports damaged

As soon as the credit crisis erupted secondary housing, the Fed began to intervene by lowering interest rates and increasing purchasing MBS Until the development of the financial crisis of August 2007, Federal Reserve System United States (Fed) has

continued to conduct monetary easing measures to boost liquidity for financial

institutions Specifically, the overnight lending rate interbank been reduced from 5.25% over 6 session to 2% only in less than 8 months (18/9 / 2007-30 / 4/2008) Interest rates are then also continued to decline and to date only 0.25% 16/12/2008, interest rates near

0 rare

The Fed also conducted open market operations (buying up US government bonds that the country's financial institutions have) and rediscount interest rate cuts Between December 2008, the Fed announced plans to implement loose monetary policy face amount

December 2007, the US government has created and delivered to the Federal

Reserve Term Auction chaired Facility program to grant short-term loans with a term of

28 to 84 days according to the highest interest rate that financial institutions pay

auction As of November 2008, there were 300 billion dollars by the Fed provides loans under this program The Fed also conducts mortgage lending for financial institutions with total amount to 1.6 trillion as of November 2008

February 13, 2008, President George W Bush signed the Economic Stimulus Act of

2008 under which the government will implement a stimulus program worth 168 billion aggregate dollars mainly in the form of personal income tax refund

Facing serious financial crisis, the Bush administration has adopted the

parliamentary finance package of 700 billion dollars Initially the US House by US Democratic majority rejected the charges, saying that money can not be too much to rescue financial institutions in trouble But after plans to use 700 billion dollars were spent for adjustment towards the program serves numerous citizens to stimulate

consumption (such as help for the unemployed, nutritional support for the poor and the low income, infrastructure development), thereby prop up the economy, it was the Senate passed October 3, 2008, President Bush signed the Emergency Economic

Stabilization Act of 2008 allows for the implementation of 700 billion dollar stimulus package this

In the period 2010-2011

Budget deficits California state tends to rise to 38.2 billion, exceeding 48% of the total expenditure estimate approved state budget Entering the period 2007 - 2008,

"bubble" of the US real estate burst, making the state a deficit of 50% of the approved cost estimates (using remedial expenditure of the crisis) Not stopping there, the state budget deficit of the state also increased to 52.8% in the period 2010-2011

Fiscal crisis of the state of California due to the following reasons:

First, revenues from taxes while reducing spending to overcome the consequences of economic crisis increases The main revenue of the state personal income tax (PIT) account for about 50%, sales taxes accounted for 35%, corporate income tax (CIT) and 11% of taxes and other charges accounted for 4 % It is easy to see, after the economic crisis - financial, people's income plummeted greatly affect personal income tax

revenues of the state, while difficult to reduce spending, leading to soaring budget deficit

In late 2001, when the "bubble" burst in information technology sector, the income

of the 50% of people, undermine aggregate demand in the economy, led to a sudden decrease in budget revenues, budget balance California break sudden switch from positive to negative Similarly, in late 2007 early 2008, the real estate bubble in the US burst, causing bank 2 (Fannie Mae and Freddie Mac) specializes pledge, lending real estate crash

After facing this crisis, the state budget deficit in the state's surge of up to 50% of total budget expenditure per period from 2008 to 2010, 2.5 times the average deficit of all the states in America