Introduction
Fiscal policy refers to the mechanisms by which a government checks its levels of spending and tax rates to control the economy of a nation. This strategy is similar to monetary policy but in monetary policy, it is the central bank of the country that regulates the country’s money supply (Ban, 2015). Normally, the government combines these two policies in various proportions in order to influence the economy of a country. Monetary policy refers to the actions that the Federal Reserve takes in order to keep the interest rates low and in the process decrease unemployment because of the many startups that will be established. During December 2007, there was a serious recession that hit the United States economy. The rate of unemployment rose to 6.7% in November 2007 from 4.4% in March 2007. There was also a drop in the number of non-farm payrolls. This sector shed 1.9 million jobs within one year from 2007 to 2008. There was a decline in the real Gross Domestic Product at the rate of 0.5 percent annually in the third quarter of 2008.
The GDP fell more rapidly in the last quarter of the year. In the last six months of the same year, there was a drop in the index of the leading economic indicators to 2.8 percent. This fall in the conference board’s index was a clear indicator that the economy was more likely to stay weak for several more months to come. Fiscal policy credits its foundation on the theories of the British economist, John Maynard Keynes (Rognlie, Shleifer & Simsek, 2018). This theory is commonly called the Keynesian economics. Simply put, this theory states that the government can affect the productivity of a country by decreasing or increasing the levels of taxes and the public spending. According to Keynes, the principal objective of the fiscal policy was to provide employment for everyone. However as time went by, modern economists came to modify this theory. Instead, the economists agreed that the role of the modern fiscal policy is to stabilize incomes, investments, and consumption. Employment stabilization is nowadays considered as the byproduct of fiscal policy. The overall effect of this government involvement is to check inflation to a healthy limit of between 2- 3 percent. The governments can also in the process increase the level of employment. In the end, there will be a healthy value for money.
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Fiscal policies
The government, through the Congress puts together different types of tax cuts and government spending. This tax cuts and government spending is what makes up the fiscal policy. Many analysts use the analogy of the “leaky bucket to explain the mechanisms and workings of fiscal policy. The increase in government spending is supposed to boost GDP growth sufficiently so as to decrease unemployment to the required levels. Because the fiscal stimulus goes through a leaky bucket whereby some of it is lost through administrative duties and hence does not have a direct effect on unemployment. This analogy was developed by Arthur M Okun who also came up with Okun’s law that state that a 1-percent increase in unemployment results to a 3-percent decrease in the growth of GDP ( Taylor, 2014). According to this law, it has been widely accepted that boosting aggregate demand is a good measure in trying to end the recession. In order for these policies to be effective, it is necessary that they are implemented rapidly. This is why during Great Recession some of the fiscal policy was carried out rapidly and automatically within the programs that were already in existence and were called the automatic stabilizers. At the same time, there was also a portion of the policy that took a long time to be implemented. These were the fiscal policies that needed to be debated in the Congress. At times, it takes a considerable amount of time to notice that a recession has begun, debate the necessary response within the legislature, pass the legislation and disburse funds to the citizens. These delays are sometimes inevitable, but it is recommended to employ automatic stabilizers in order to quickly help the affected individuals and the state in general.
In 2009, there was The American Recovery and Reinvestment Act of 2009 (ARRA) that was passed by the legislature to help stimulate the economy after of recession. This Act authorized spending on healthcare, education, and infrastructure. In the process, automatic stabilizers were expanded and various tax cuts were introduced. The automatic stabilizers stimulate the economy instantaneously during the recession and they do not need additional action from the Congress. Examples of automatic stabilizers that were employed during the Great Recession are Unemployment Insurance (UI), Medicaid, and Supplemental Nutritional Assistance Program (SNAP) that was previously called food stamps ( Taylor, 2014). Participation in these programs increases automatically as soon as recession arrives because of a decrease in the circulating income and increased rate of unemployment. Participation also increases at times because of the decrease in eligibility of the participants. The end result of these stabilizers is that there is a reduction in taxes and hence providence of a fiscal stimulus. During the Great Recession, the United States made use of automatic stabilizers to a considerable degree. Automatic stabilizers amounted to 2 percent points of GDP during the Great Recession.
As there was an increase in the unemployment and a spike of poverty, two major programs were forced to respond differently. These programs were the Unemployment Insurance and the Temporary Assistance for Needy Families (TANF). There was an increase in the claims for the Unemployment Insurance due to the increase in the number of unemployed individuals in the states. The UI buffered the eligible workers against losses due to lack of an earning ( Taylor, 2014). It is worth noting that not all the unemployed individuals were eligible for the insurance but the program went a long way in helping most of the unemployed people in the United States during this time. TANF succeeded Aid to Families with Dependent Children. This program was not as successful as UI as it hardly grew with the increasing poverty. Up to now, this program is not structured to effectively respond to the ever-varying poverty cycle and the same time it is not viewed as an automatic stabilizer. TANF, however, has been credited with fighting deep poverty in some of the instances.
The first large government injection took place during the presidency of G.W. Bush. The money was used to purchase financial assets that were not doing well in the struggling private banks. Despite these purchase being carried out by the Federal Reserve they still constituted the fiscal policy because the Federal Reserve cannot buy financial assets from private banks without the authority from the Congress. The Federal Reserve was given a budget of seven hundred US dollars by the Congress. The Fed was supposed to buy the asset-backed securities under the first Troubled Asset Relief Program (TARP). The TARP additionally infused funds into Citi group and General Motors and eventually led to the nationalization of AIG insurance company (Rognlie, Shleifer & Simsek, 2018). The purpose for this TARP was to stabilize the banks so as to get money flowing for the sole reason of financing investment. The other part of fiscal stabilization plan was carried out by President Obama under the American Recovery and Reinvestment Act of 2009 (ARRA). This policy was slightly modified in that instead of it being used to buy financial assets that were not performing from private institutions, it was used to purchase goods and services from firms and to give real income aid to the state and individuals. This policy allocated 787 billion US dollars in addition to the money that had been appropriated under TARP. Of this amount, 288 billion USD was in form of tax cuts, 224 billion USD was in form of entitlements and 275 billion USD was in grants, contracts, and loans.
It is believed that the fiscal stimulus in ARRA helped reduce the severity of the Great Recession. It is estimated that this bill helped the GDP increase by an estimate of between 0.4-2.3 percent by 2011. It has been argued that business tax cuts are less effective compared to that stimulus that is aimed at low-income families. According to calculation and past experience, tax cuts are less effective compared to government spending when trying to stimulate the economy. The reason for the decreased efficacy of tax cuts is because individuals only get to spend a fraction of the stimulus provided. It has also been pointed out that across all the stimulus type, during a recession it is better to put in place fiscal stimulus. Fiscal stimulus has not been found to be effective during expansions. The combined budget for both the TARP and ARRA was approximated to be 10% of the GDP. This budget was inadequate in steering the economy in the direct direction as the net effect on the growth of GDP and unemployment was small (Ban, 2015). There was no significant growth in the economy because as the Federal government increased its spending, the individual states, firms, and households reduced their spending and hence offset much of the effect. The TARP did not boost output because it generated demand for non-employment inducing demand.
Conclusion
From this discussion, it can be seen how the G.W. Bush and the Obama administration tried to counter the Great Recess in the United States by employing fiscal policy. The Bush administration was credited for the TARP program while Obama’s administration initiated the ARRA program. Even though these programs contributed to the containment of the recession menace, some of the economic critics feel that the effect of these programs was not of so much help in helping the country return to its economic boom.
References
Ban, C. (2015). Austerity versus stimulus? Understanding fiscal policy change at the International Monetary Fund since the great recession. Governance , 28 (2), 167-183.
Rognlie, M., Shleifer, A., & Simsek, A. (2018). Investment hangover and the great recession. American Economic Journal: Macroeconomics , 10 (2), 113-53.
Taylor, J. B. (2014). The role of policy in the Great Recession and the Weak Recovery. American Economic Review , 104 (5), 61-66.
