Public Administration and Fiscal policy

Public Administration and Fiscal policy

Part I: Fiscal Policy

Section 1: Fiscal Policy and the Recessionary Gap

1. The government can use expansionary fiscal policies to close the recessionary gap. This will involve decreasing taxes or increasing spending. For inflationary gaps, the government uses contractionary fiscal policy, such as raising taxes and

reducing expenditures.

1. In solving the recessionary gap, policymakers increase government spending or lower taxes. Increasing government spending results in a shift in the demand curve to the right, which then closes the recessionary gap. If the government increases its spending on products and services, it means that there will be more money in circulation in the economy. As the government buys, it pays in terms of cash or any other form, meaning that those who sell will have more money to spend. Consequently, there will be more money to spend increasing the consumer’s purchasing power (Inman & Rubinfeld, 1991). An increase in consumer purchasing power means an increase in the aggregate demand, which shifts the demand curve to the right, closing the recessionary gap. On the other hand, if the policymakers lower taxes on disposable income and consumer goods, then it means that there will be more money to spend and on tax reduced products. Such situations result in impulse buying, which then increases aggregate demand. An increase in the buying rate results in a shift demand curve to the right, which then closes the recessionary gap.

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2. Increased government spending may result in deficits in the national budget. In the federal budget, a rise in government spending may lead to both debt and surplus. Further, the increased government may lead to an increase in national GDP. During a recession, people tend to reduce their spending resulting increase in savings in the private sectors of the economy. If the situation continues and the government spends more, then the multiplier effect may be realized in the economy. It is important to note that there are two types of federal spending, and each has a different effect on the budget (Inman & Rubinfeld, 1991). Spending that result in money being circulated within the locality, and there is spending that attracts people to the locality. The former has an effect of stabilizing balancing the budget hence increasing the real GDP while the latter may result in deficits with GDP increasing at a lower rate. A decrease in tax on disposable income had the effect of deficits on both the national debt and federal budgets, while an increase of tax on disposable income increase budget surplus on for the national and federal budgets.

Section 2: Fiscal Policy and the Inflationary Gap

1. For inflationary gaps, the government uses contractionary fiscal policy, such as increasing taxes and decreasing spending.
2. In curbing the inflationary gap, the policymakers reduce the government’s both domestic and foreign spending. This has the effect of reducing the money in circulation, which then reduces consumer’s purchasing power. Once consumers have less money to spend, then their demand for goods and services also reduce. Consequently, the aggregate demand curve shifts to the left, closing the inflationary gap. Besides, the government can also close the inflationary gap by increasing taxes on consumer goods and disposable income (Inman & Rubinfeld, 1991). If taxes on consumer goods are increased, then the price of the goods will rise. According to the law of demand and supply, an increase in price results in a decrease in aggregate demand. This then shifts the demand curve to the left, closing the inflationary gap. Further, a rise in tax on disposable income results in to decrease in the total amount the consumer is willing to spend, which then reduces their purchasing power. This then leads to a decrease in the aggregate demand curve to the left, closing the inflationary gap.
3. An increase in taxes increases the amount of money that the federal government budget with and decreased the national debt hence increase the real GPD of the economy. High taxes on both gross income and consumer goods imply that the federal government will have a high amount of money to use in budgeting. It, therefore, means that the federal budget will not have deficits but surplus. The national debt will reduce because the government will have enough money to pay its debts and also budget without borrowing. Also, when the government cuts its spending, then it will spend less based on its budget constraints without necessarily borrowing. Reduced borrowing reduces the national debt hence stabilizing the economy.

Part II: Monetary Policy

Section 1: Monetary Policy and the Inflationary Gap

1. To control inflation problems, the central bank uses contractionary monetary policy to reduce the amount of money in circulation.
2. Some of the monetary policies used to control inflation include high-interest rates on loans, increasing reserve deposits, and open market operations. The primary aim of these monetary policies is to reduce the amount of money supply into the economy. For example, through the central bank, policymakers can instruct commercial banks to increase their reserves with the central bank. Reserves are compulsory deposits that every bank is expected to keep with the central bank for security issues. If the banks increase their reserves with the central bank, then they will have less money to give out in the form of loans. Another most commonly used policy in open market operations (Bohn, 2008). In the case of inflation, the government sells its securities to extract money from the economy, therefore, reducing the amount of money in the supply. In extreme cases, the government may be forced to instruct both commercial and central banks to raise their interest rates on loans. High-interest rates on loans discourage people from borrowing, therefore, reducing the amount of money in circulation. Monetary policies have the effect of reducing inflation by reducing the amount of money supply in the economy, thus decreasing consumer’s purchasing power.
3. Inflation means there is an excess amount of money in the economy chasing few goods and services. Monetary policies aim to reduce the amount of money supply into the economy. Monetary policies have the effect of reducing inflation by reducing the amount of money supply in the economy, therefore, decreasing consumer’s purchasing power. If there is a controlled amount of money in circulation, then the price of goods and services will re-adjust to market equilibrium.

Section 2: Monetary Policy and the Recessionary Gap

1. If the economy faces a recessionary gap, then policymakers can use expansionary policy to increase the amount of money in circulation.
2. Duarte & Schnabl (2019) noted that the monetary instruments used to close the recessionary gap include open market operations that involve buying securities, lowering reserve rates, and lowering discount rates. In this case, the government uses open market operations in that it buys its securities from the public, consequently releasing money in the economy. If the government buys its securities from people, they pay those individuals who then circulate the money in the system. This increases consumer’s ability to buy goods and services, which then results in to increase in aggregate demand. This then leads to a shift in the demand curve to the left hence closing the recessionary gap. Besides, when the economy faces a recessionary gap, the central bank is instructed to reduce the amount of reserve requirement for commercial banks. The earlier deposits are also released to the banks. The commercial banks will then have enough money to lend to people. In connection, financial institutions are commended for reducing their interest rates on loans. With a high amount of money to give and at low-interest rates, many people will be willing to borrow, and the banks will have enough to lend, therefore increasing the money supply in the economy. An increase in the amount of money in circulation results in to increase in aggregate demand, which closes the recessionary gap.

Part III: Fiscal and Monetary Policy Applications

Recession and inflations have adverse consequences on the United States economy. To avoid these consequences, the government implements specific and appropriate monetary and fiscal policies to help stabilize the economy. Without the rectifying systems, the economy can suffer a high rate of unemployment, low opportunities, low wages, and incomes, among others. Further, in the current downturn, there may be an economic strain in education, health, capital investments, and economic opportunities (Duarte & Schnabl, 2019). Inflation is associated to more worse economic evils such as an increase in the opportunity cost of holding money, prolonged run increase in interest rates, reduction in savings, increase in taxes, mal-investments, and a decrease in the employment rate. Through continuous changes in fiscal and monetary instruments, the United States government and policymakers have ensured that the economy in a condition of expansion. By 2018, the United States economy was one of the world’s largest economy with a GDP amounting to around $20.513 trillion (Wang, 2019). The high growth rate is associated with high average income, technological innovation, young population, high rate of capital investment, moderate unemployment rate. Wang (2019) noted that currently, the country has an increase in the growth rate of 3.1% as compared to a 2.5% increase registered in 2018.

Due to the changes in the monetary and fiscal instruments, the United States’ economic condition currently is considered to be sound. The policymakers have applied appropriate instruments to control money supply in the United States economy to ensure expansion within manageable limits. The real GDP growth rate is expected to shift from 2% to 3% (Wang, 2019).  The government has controlled the inflation rate at 1.93% via changes in interest rates and discount rates. Further, through controlled government spending, policymakers and economist have ensured that the United States debt remains at $23.08 trillion inclusive of public and intergovernmental debts. The United States has maintained a flexible income tax bracket with 37% at the maximum and 10% at the minimum, which is inclusive and affordable (Wang, 2019). The tax system is designed in a way to curb shifts in inflation and recession gaps, therefore ensuring the employment rate is maintained not below 3.6% by 2019 (Wang, 2019). The country is noted to perform well as compared to other developed economies such as China because it has managed recession and inflation. For states to have a sound and positive economy, specific shifts are required in both the fiscal and monetary instruments such as interest rates, taxes, government spending, and discount rates, among others. This will ensure an economically desirable amount of money in circulation to maintain aggregate demand and supply and prices hence keeping market equilibrium for economic stability.

References

Bohn, H. (2008). The sustainability of fiscal policy in the United States. Sustainability of public debt, 15-49.

Duarte, P., & Schnabl, G. (2019). Monetary policy, inequality, and political instability. The World Economy, 42(2), 614-634.

Inman, R. P., & Rubinfeld, D. L. (1991). Fiscal federalism in Europe: lessons from the United States experience (No. w3941). National Bureau of Economic Research.

Wang, S. (2019, May). The United States Economy in 2019: Moderate Growth, Flexible Monetary Stance, and Fluctuating Financial Market. In 2019 5th International Conference on Humanities and Social Science Research (ICHSSR 2019). Atlantis Press.