The this would ‘jumpstart consumption demand and thereby

The US government responses to mitigate the financial crash and its effects afterwards are very Keynesian in their nature.  What should be noticed is that governments hardly ever only use fiscal or monetary when trying to steer the economy, it is often a combination of the two which is known as a Policy Mix (could add islm graph). This is definitely the case here and although I will talk about the policies separately here for the ease of the reader, both were applied injunction with another. Broadly speaking, the government set out to accomplish two goals: to stabilize the sickly financial system and to mitigate the burgeoning recession, ultimately restarting economic growth (mark zandi)


Fiscal policy:

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Countercyclical fiscal policies which comprise of ‘expansionary fiscal measures and the use of automatic stabilizers’ have ‘generally helped shorten recession spells in advanced economies during crisis episodes’ (IMF, 2009b, IMF, 2010b) which is what Keynesian ISLM model predicts that the drop in private consumption should be countered by an expansion of government expenditure in order to hopeful decrease and neutralise an economic collapse. However, deciding how successful the US fiscal response will hinge on the accompanying ‘macroeconomic policies and design of fiscal stimulus packages’ along with the size of government and tax multipliers (from ISLM)(imf 2012).

the biggest example of American fiscal stimulus package was the American Recovery and Reinvestment Act (ARRA) which was implemented by President Obama in February 2009. The final bill is estimated to $831 billion with the primary aims to create new jobs whilst protecting existing jobs, aswell as investing in sectors such as health, education, renewable energy and infrastructure.   Influential economists such as Taylor in his September 2010 address to (maybe congress) argued that the federal fiscal policy which ‘took form as short term stimulus package…didn’t stimulate economy much if at all’ instead he even went as far as to say the government intervention left the economy ‘weakened…with debt burden and future tax concerns.’ He provided statistics to back up his argument stating in late 2010 unemployment was at 9.6% and GDP growth was low at 1.6% with the forecast for these two figures expected to remain bleak due to ‘uncertainty about economic policy including the burden and risk of government debt’

A component of the ARRA was focused on increasing the publics disposable income by increasing tax rebates and giving money to households. The US Government hoped this would ‘jumpstart consumption demand and thereby the economy.’ (3rd) However there were some flaws noticed in the economic theory behind this. First of all, tax rebates given by government were ‘undermined by their temporary nature’ which failed to increase consumer spending as house households are not myopic thus aggregately there was ‘no noticeable effect on consumption'(3rd). Also in February 2008 when checks were sent to households there was ‘no personal consumption increase'(3rd). Both these outcomes are deduced from the permanent income theory and the life cycle theory of consumption—would predict from such temporary payments. Instead it is advised that tax rebate could be applied in the form of ‘temporary price reductions…especially on durable goods’  which would have worked in by increasing the deamand and hence consumption for these provisions due to the ‘short term nature of the policy’ thus shifting out the IS curve and increasing Y. , while being temporary undercuts the income effect on consumption, it would increase the substitution effect.

Next consider the government purchases part of the stimulus package of 2009, also designed to stimulate economic growth. An examination of what actually happened indicates that such purchases had little to do with the recovery in economic activity, and they have not prevented the recent slowdown. Data from the Bureau of Economic Analysis provide the evidence: Changes in government purchases did not correlate with the changes in economic growth from recession to recovery. On the contrary, most of the recovery last year has been due to investment—including inventory investment—and has little to do with the discretionary stimulus package.

Taylor states that the effect is so small due to the fact by halfway of 2010 only ‘0.3% of the $862 billion has been spent on federal infrastructure projects’ which he says represents a ‘decrease of government gross investment and consumption purchases’ since the crisis started.  Further taylor states that impact of the stimulus is much smaller than proclaimed by the governemtn due to results being dependent on ehst mofel. old Keynesian models show large effects and more modern models show smaller effects. The IMF uses a very large complex model called the Global Integrated Monetary and Fiscal (GIMF) Model. It shows that a one percent increase in government purchases (as a share of GDP) increases GDP by a maximum of 0.7 percent and then fades out rapidly. This means that government spending crowds out other components of GDP (investment, consumption, net exports) immediately and by a large amount.


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