Commentary Number 1

Christoffer Knutsson Economics SL
Commentary Number 1
The Obama administration in the U.S has accepted a crisis package worth somewhere between 500-600 billion dollars, to help bring the economy out of the deep recession1.This is known as Fiscal Policy2 and it is hoped to promote investment and thereby cause a growth (i.e. bring the economy into a state of recovery) in the falling GDP (Gross Domestic Product). Business Cycle GDP Boom Peak
Recovery Recession Trough
Time Negative growth in GDP occurs when people decide to save money instead of spending, causing a drastic decrease in demand. The government investment of 500-600 billion dollars would be an injection into the circular flow in an attempt to achieve the real balance effect3. This will cause a higher demand and thereby also a higher supply of the goods and services produced i.e. creating growth and putting the country into a state of recovery. In a recession, expansionary policies are to be used in order to reach equilibrium in the aggregated supply curve. By increasing government spending (Fiscal Policy) the Obama administration hopes to cause an increase in the aggregate demand so that the LRAS4 and the SRAS5 will be in equilibrium. Until the crisis package is put into use the U.S will experience further negative growth, lower inflation rate, increasing unemployment, and possible trade surplus. The effects of the crisis package is then hoped to be decrease in unemployment, increased output, and societal benefits.
1 2
Two consecutive quarters (six months) of negative growth. When the government influences the aggregate demand by boosting government spending. 3 Suggests that the larger the amount of real money in the economy, the higher the quantity of goods and services real GDP will be demanded. 4 Long run aggregate supply 5 Short run aggregate supply
Christoffer Knutsson Economics SL P LRAS SRAS P1 P0 AD0 Y0 YFE AD1 GDP
Another major problem for the U.S is her budget deficit, close to 1000 billion dollars. This enormous deficit is due to that the government has spent too much money on things that has been outside the government budget outline, for example the financing of war, i.e. they have had greater expenditures6 than receipts7 The reason for why this might cause a huge problem is that in order for them to finance the deficit the government will have to borrow money. This national dept that it is then called can later severely hinder the governments future fiscal freedom, which could cause great troubles at the next recession period. Even though it might seem as if Fiscal Policies are an excellent way of controlling the curve of the business cycle and achieve macro objectives, such as growth and low unemployment, it is not completely risk free. Governments that interfere too much can actually make things worse, seen in the diagram below. This will result in that the economy will never reach price stability8, but always shift between boom and recession and these shifts will be more and more present. This is very damaging for the economy since they lead to great unpredictability for both firms and households, making it difficult for firms to plan input and output while it adds insecurity to households, thereby causing the shifts. The reason for why governments might make things worse by implementing fiscal policies is due to the fact that there are lags built into the macroeconomic system. These lags are the identification lags9, decision and implementation lags10, and effect and impact lags11.
6 7
Money spent on defence, education, health care etc. Money received by taxation, profit from state-owned enterprises, social security contributions etc. 8 A low and steady inflation. 9 Occurs simply because it is always difficult to know where one is at on the business cycle. 10 Occur because it takes time for the political and administrative process to result in a policy decision. 11 Occur because it takes time before government spending actually has an impact on the economy.
Christoffer Knutsson Economics SL
GDP with active fiscal policies GDP
Desired trend of GDP
GDP without active fiscal policies
Time The US health care system is the most expensive one in the world, not less then 46 million people lack health insurance or has a very poor insurance coverage12. The deep recession makes it close to impossible to deal with that issue at a current point of time. What can be done is that as soon as the economy has stabilized, taxes could be raised in order to finance a spread of insurance coverage. Another thing that could be done would be to use fiscal policy again with the intention of financing a solution to the problem. However, this would add to the already huge budget deficit which might cause later complications for the economy.
12
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Commentary Number 1

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Christoffer Knutsson Economics SL

Recovery Recession Trough

Christoffer Knutsson Economics SL P LRAS SRAS P1 P0 AD0 Y0 YFE AD1 GDP

Christoffer Knutsson Economics SL

GDP with active fiscal policies GDP

Desired trend of GDP

GDP without active fiscal policies

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