LCB/2356
Explain the predictions that the OECD have made concerning the US economy, making sure that you define the terms “Budget Deficit” and “Debt” in your solution.
A budget deficit is when the nations is spending more then their revenue received. This would mean that expenditure exceeds tax revenue resulting to a budget deficit. The term “Budget Deficit” is usually used to refer the government expenditure rather than businesses.
A debt is an amount of money that is owed to another person or organizations. A debt is usually repaid after a certain amount of time given or when is able too depending on the situation. A debt is a method that is used for some corporation or businesses for making a large purchase of something that they cant afford.
The prediction made by the OECD with the budget deficit of 2011 being tacked at 10% of Gross Domestic Product (GDP) and the American debt increasing to 101.1% of GDP. This helps prove the fact that the American government is spending way more than its actually receiving in revenue.
This would also help us assume that the American government is putting into effect on the fiscal policy which means that the government increases their spending and decreases taxation. This would lead to budget deficit as expenditure surpasses revenue.
There are two schools of thought on how the US government should deal with its current economic problems
Deficit Reduction
As for the Greek and Irish Governments, Deficit reduction entails a fiscal policy where it decrease the governments spending and increases the taxation rates in order to increase revenue. The objective of a deficit reduction is to make sure that the revenue that the nation is getting are greater than the expenditure that they are doing. Therefore reducing the deficit and possibly bringing about a surplus in budget. A budget surplus would help the nation pay its debts therefore giving the government a capable of developing without having have to repay theirs debts in long term which will also ease up the political tensions with other nations economically.
Contractionary fiscal policy, while the budget deficit is reduced and also decreasing the national’s debt, it also has a lot of disadvantages to it. As it decreases the expenditure, aggregate demand would decrease because it is Consumption + Investment + government Spending + (Export – Imports) (C+I+G+(X-M). As increasing the taxes it would reduce the aggregate demand therefore it may cause disincentives to work therefore it would affect the productivity, However this would not effect is the income is really high and balances out with the higher tax. As the government’s spending decreases this would also lead to increase in unemployment which would lead to decrease in consumption because there is no money to be spent by the general population.
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As shown in the graph above of a contractionary fiscal policy. The decrease in the amount of government spending, G in C+I+G+(X-M) leads to the Aggregate Demand Curve shifting inwards from the AD to AD1. Therefore this will decrease the price level which is an indication of inflation in the economy as shown from PL to PL1. This would also lead to the Real Domestic Output to be decrease from RDO to RDO1.
We have to consider the long term affects of Contractionary Fiscal Policy that while it allows a decrease in debt, decrease in spending and increased revenue which reduces the budget deficit. The problem that arises from this as unemployment and decrease in government spending will result in low economic growth and giving it slow progression.
Fiscal Stimulus and Progressive Taxation
Another school of thought regarding the plan of action to deal with the ongoing American economic crisis is to implement a Keynesian stimulus package with the reform of the tax system in order to make it more progressive. A Keynesian stimulus package is when the government puts in more money in the economy in order the strengthen the economy and preventing a recession by boosting employment and spending, this is also known as a expansionary fiscal policy. A Expansionary Fiscal Policy seeks to expand the money supply in order to have a higher economic growth. The long term effects of expansionary fiscal policy would also have to be considered, Constant economic growth, more job employments, and also more consumption which helps with the economy. However, As the economic grows the inflation rates does too, it also leads to an increase of budget deficit as the expenditure is higher than the revenue gained and increasing the debt that the government would borrow, which eventually would have to be repaid. Therefore as for the government to spend more they would have to increase the taxation to balance out the revenue and expenditure.
A progressive tax system is when the taxable base amount increase, the tax rates would too. This refers to the more money the person or the organizations makes, the more tax they are charged and the less they are making the less tax they would have to pay. This aims to allow the lower tax payers to be able to keep more money in order for them to continue consuming while increasing the tax revenue. However, people in the higher tax bracket would find this unfair because they would rather everyone pay the same amount therefore implementing this system would make it hard. One of the main goal of the progressive income tax is to make it a tool for redistributing income from the upper class to the lower and middle class, this would help keep the income gap from growing between the rich and the poor. It would also give more revenue to the government because they are collecting more money from the higher incomer earners. This is make the government collect more money from the tax payers rather than if everyone had to pay the same amount or percentage. As a result, this would help the government develop or provide more programs and services that benefit the society. However progressive tax system also has some disadvantages for it, One would be that some businesses would be discouraged to expand or invest as additional profit is taxed at higher prices. It would also make people feel discrimination as I said before the higher tax earners would see it unfair to them because this system doesn’t promote equality amongst individuals.
As shown in the graph above, Its showing the effects of the expansionary fiscal policy, when the government spendings are increased leading to an increase in aggregate demand from AD to AD1 as G in C+I+G+(X-M) making the Aggregate Damand curve to shift inwards. This would also mean that the increase in Price Level, Which is from PL to PL1 and an increase in Real Domestic Output, Which is from RDO to RDO1.
Explain in broad terms the background to the “Credit Crunch” and how this impacted on the real economies of both the USA and the UK
The “Credit Crunch” also known as the financial crisis of 2007 to 2008 is the worst global financial crisis since the “Great Depression” of the 1930s with its after effects still being considered still as shown by the Euro Crisis.
There may be a number of reasons which may include of the credit crunch but its not limited to; the burst of the housing bubble in America, Lack of banking regulation, however the biggest cause would be the encouraged risk of taking from years of stable economic growth and low inflation rates which makes the borrowing and purchasing of bad securities and properties. The housing bubble of America started earlier in 2006 as the house prices were all risen up more than 100%, this is beause of the ease of attaining mortgages at that time. This led to people deciding to take loan and acquire additional property in order to take advantage of the higher value in properties, in other words to buy and resell properties to make a profit. Regardless of that, people in the end are not able to pay their loans because of predatory lending, which is when the loans are advertised at a low interest rate but are switch out to adjustable rate mortgages where the interest charged would be higher amount of the interest paid. This then led to people having have to lose their properties and also leading to a huge decrease in property prices. Therefore this would lead up to a liquidity issue however banks had no liquid assests and leading to the decline and eventually bankruptcy of many banks. The collapse of the mortgage repayment was considered the start of the financial crisis.
Another reason would be that the lack of financial regulation and supervision of financial institution who were involved in the risky investments, excessive borrowing and lack of transparency. The borrowing of money made by many banks in order to invest in their project usually ended up being a failure resulting of the bank investing on something that they cant make profit off therefore giving them the inability to repay their debts. The fact that this happened in a very large scale in cooperating many different banks linking each other, it led to the bankruptcy of both borrowers and lenders giving them no more or insufficient money to function.
References
http://www.investopedia.com/terms/e/expansionary_policy.asp
(Accessed 20.11.14 [Online])
http://www.econport.org/content/handbook/ADandS/AD/Shift.html
(Accessed 20.11.14 [Online])
http://www.sparknotes.com/economics/macro/aggregatedemand/section1.rhtml (Accessed 20.11.14 [Online])
http://www.ehow.com/info_7742308_pros-cons-budget-deficit.html
(Accessed 20.11.14 [Online])
http://www.investopedia.com/terms/s/stimulus-package.asp
(Accessed 22.11.14 [Online])
(Accessed 22.11.14 [Online])
http://hubpages.com/hub/Flat-Tax-vs-Progressive-Tax-Pros-and-Cons-for-the-US (Accessed 23.11.14 [Online])
http://education-portal.com/academy/lesson/progressive-tax-system-definition-pros-cons.html (Accessed 23.11.14 [Online])
http://www.investopedia.com/terms/c/creditcrunch.asp
(Accessed 26.11.14 [Online])
http://www.investopedia.com/university/credit-crisis/credit-crisis4.asp
(Accessed 26.11.14 [Online])
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