Budget and spending
During a recession, consumers reduce spending leading to an increase in saving and reduction in spending by the private sector spending due to a decline in the demand for goods and services. Apart from the private investors restricting their investments, factories and manufacturing plants also reduce their production and lay off workers. Consequently, more and more businesses continue to lay off workers since it lacks the capacity to employ them. On the other hand, the government revenues which are primarily drawn from taxes also progressively decline. Ideally, this forces taxpayers to cut back on many essential services such as law enforcement, emergency services, education as well as maintenance of infrastructure. To prevent this downward spiral, spending has to be encouraged. To revive the economy during a recession, the government with the onus of increasing its expenditure without necessarily increasing taxes since the private sector is incapable of rendering significant spending. However, the spending has to significant enough to cause an impact.
Expansionary fiscal policies may take the form of tax cuts or increase in government expenditure initiatives which seek to trigger economic demand essential in boosting the output level. At the instance in which taxes exceed government spending, the government is said to have obtained a surplus. A balanced budget is achieved by equating taxes with government expenditures while deficits occur when the expenditures exceed the revenues and at this instance, there is need for a fiscal stimulus only achievable through expansionary fiscal initiatives. Only an effective fiscal stimulus adopted during a recession can spike the economic growth. The adoption of the expansionary policy by the government is however controversial as there is a lack of consensus concerning the merits and impacts of the fiscal stimulus (Niskanen, 1978). Proponents of fiscal stimulus argue that increased government spending generates the following merits to the economy:
With an efficient stimulus package job, creation will commence rapidly (Goodman, 2013) Recommends that the spending ought to be labor-intensive in the sense that the government should invest largely on projects such as construction, education, communication networks, large power generation as well as other major infrastructure projects which benefit the community. For example, during the great depression in the 1930s, TVA was created and this created jobs which helped come out of the depression.
Increased government spending creates a multiplier effect. Given the fact that the jobs are available, their incomes increase causing them to demand more goods and services. When consumers have more money, they can create demand for products and services, and this will prompt enterprises with capital to invest in the production of commodities. The positive ripple effects will continue, and the tax revenues will increase, and deficit financing will not be needed. The increased aggregate demand and incomes in the economy translate to and increased gross domestic product in the economy. The government will increase its tax revenues as a result of higher economic activity, and this will help reduce the budget deficit in the long run (The Economist, 2015).
However, opponents argue that increase in government spending leads to higher taxes in future. The argument is indeed true as this might be quite hefty for the regime that rules in the long run (Stuckler, Basu, Suhrcke, Coutts & McKee, 2011). Additionally, governments cannot spend money quickly and wisely, and if governments try to increase its spending, it may end up purchasing things of little public value. The households, on the other hand, tend to spend their disposable income on things they value while firms spend their investment dollars on projects they expect to be profitable. Widening the budget deficits tends to be monetized and subsequently lead to higher inflation. Other arguments held posit that increasing government spending through increased taxes would result in a more inefficient allocation of resources as states tend to be less efficient in spending money (Cogan, Cwik, Taylor & Wieland, 2010).
Running budget deficit stifles the balanced budget, and the government has to issue bonds – an action which raises interest rates since the government borrowing increases demand for credit in the financial markets. If the economy was operating at full capacity, increased government spending would tend to crowd out the private sector leading to zero net increase in AD from shifting from private sector spending to the public sector, and this stifles the economic growth.
- Zero-inflation target
Inflation targeting is an economic tool and policy used by the central bank in steering the inflation level rise towards the set target. The government sets the inflation target of consumer price index (CPI) at a given percentage. The United States, Federal Reserve, for example, maintains the inflation target range at 1.7 percent – 2 percent. Inflation rate and interest rate are inversely related but do not however always succeed in affecting inflation. Though inflation targeting aims at controlling inflation, it may limit the flexibility of the central bank. When the inflation falls below the targeted range, the FED lowers the interest rates and raises the money supply to catapult inflation (Goodman, 2013). Conversely, when inflation is above the inflation target, the FED increases the interest rates and decreases the money supply to suppress the high level of inflation.
ARGUMENT FOR
Proponents for inflation target argue that a volatile inflation rate has adverse effects on the economy. Ideally, heightened levels of inflation drain savings, increase prices of goods, discourage lending, and may create inflationary pressure which paves the way for hyperinflation. However, inflation targeting can help maintain the inflation levels and avoid many other adverse effects (Bernanke & Mishkin, 1997). Moreover, when consumers anticipate a rapid increase in prices, they tend to spend much of their money to evade paying higher prices in future. However, this increases the demand and pressure for the available goods before finally causing inflation to occur (Vestin, 2006). On the other hand, when households anticipate a deflation, they tend to save their money and delay consumption until prices fall. In effect, this decreases the demand for goods and services thereby causing manufacturers to sell their products at lower prices (Svensson, 1999). Through inflation targeting, consumer’s expectations are set thus making a particular inflation level easier to maintain. It goes without saying that zero long-term inflation is beneficial to the economy because it enables long-term planning plausible. Consequently, relative price movements become clearer, dependable and determinable (Romberg, 2016). With the targeting put in place, there is no need to worry about deflation or a regime of falling prices.
ARGUMENTS AGAINST
It is successful in maintaining the inflation at low levels and avoiding many of its adverse effects. Some posit that the costs of inflation targeting may exceed the benefits. If implemented, inflation target could severely limit the Central Banks’ flexibility in responding to changing economic conditions (Svensson, 1999). At times, higher inflation is encouraged as it stimulates spending. A Central Bank that puts in place a strict inflation targeting would not be in a position to permit inflation rising above targets no matter how beneficial it would be. On the other hand, a low inflation level may trigger deflation. The fear is that if inflation is too low, deflation may set in. With deflation, the real value of debt and interest rates rises. A low level of inflation causes problems for people to pay back their debts. Also, rising real interest rates discourages borrowing and investing and instead motivates investors to save. When the economy is depressed, this increase in real interest rates can make monetary policy less effective in stimulating growth.
It goes without saying that little inflation is indicative of moderate growth. If inflation falls to 0percent, it suggests that there is an intense price pressure to encourage spending and the recovery is very fragile. Low inflation could be a blessing in disguise. Another argument against zero inflation targeting is the fact that inflation is not necessarily attached to variables influencing the economy and it is hence not the best variable to target (Bernanke & Mishkin, 1997). Zero inflation creates substantial costs to the economy especially when firms are reluctant to cut wages. Given that other enterprises perform better than others, payments need to adjust to accommodate these differences in economic fortunes.
Conclusion
I tend to think that increasing government spending to mitigate recession is necessary. Deficit government spending during a recession is a good debt as it meets all conditions of good debt since it is critical and necessary for investment (The Economist, 2015). The borrower has the capacity or has a solid plan to repay the debt. However, when there is no recession, the government should not lower taxes.
I do not support zero inflation targeting. Ideally, this is because some level of inflation is necessary to an economy running. Economic growth is paramount to the economy. During deflation, employment levels, wages and productivity declines an in the overall, zero inflation would wear out the resistance of employee’s to wage cuts (Romberg, 2016). Setting the inflation level at a certain manageable level is reasonable and acceptable. The Central Bank ought not to raise the interest rate even if inflation is above the target level during recession period. The central banks should maintain the optimum level of inflation.