Question

The conventional fiscal policy to fight a recession would be to (LO9) a) increase the rate of monetary growth b) decrease the rate of monetary growth c) run budget deficits d) run budget surpluses

Short answer

The conventional fiscal policy to fight a recession (LO9) is to: c) run budget deficits

Step-by-step solution

Reviewing fiscal policy

Fiscal policy is the use of government revenue collection (taxes) and expenditure (spending) to influence the economy. Fiscal policy is usually implemented to stabilize the economy and avoid significant fluctuations, such as inflation or recession. During a recession, the primary aim of fiscal policy is to stimulate economic growth and reduce unemployment.

Option A: Increase the rate of monetary growth

Increasing the rate of monetary growth refers to increasing the money supply in the economy. This is an action associated with monetary policy, not fiscal policy. Monetary policy is managed by the central bank and is a separate method for managing the economy. Therefore, option A is not the correct application of fiscal policy.

Option B: Decrease the rate of monetary growth

Decreasing the rate of monetary growth is also an action related to monetary policy and not fiscal policy. This method aimed at slowing down inflation or an overheated economy, which is not our focus during a recession. Hence, option B is not the correct application of fiscal policy.

Option C: Run budget deficits

Running budget deficits means that the government spends more than it collects in revenue (taxes). This option can be considered a conventional fiscal policy during a recession. In such situations, governments may choose to increase spending or reduce taxes to stimulate the economy, even if it results in a temporary budget deficit. This approach helps increase demand in the economy, leading to businesses creating more jobs, and ultimately promoting growth.

Option D: Run budget surpluses

Running budget surpluses is when the government spends less than it collects in revenue (taxes). This action is not commonly used to fight a recession as it may further reduce demand and economic activity, which could deepen the recession instead of alleviating it.

Conclusion

Based on the analysis of the given options, we can conclude that the conventional fiscal policy to fight a recession (LO9) is to: c) run budget deficits

Key concepts

Recession

Recession refers to a period where the economy experiences a decline in activity. It is characterized by a fall in Gross Domestic Product (GDP) for at least two consecutive quarters. During a recession, consumer and business spending decreases, leading to lower demand for goods and services.
This results in companies cutting back on production and often reducing their workforce, which increases unemployment rates.
An important aspect of understanding recessions is recognizing their impact on economic confidence. When people expect economic downturns, they may further reduce spending and investment, exacerbating the situation. To combat a recession, governments use various strategies to boost economic activity:

• Increasing public spending on infrastructure projects to create jobs.
• Lowering taxes to increase disposable income for consumers.
• Providing financial support and incentives to small businesses and industries affected by the downturn.

These measures aim to restore confidence and stimulate growth by encouraging spending and investment within the economy.

Budget Deficits

A budget deficit occurs when government spending exceeds its revenues, often measured over a fiscal year.
In the context of fiscal policy, running budget deficits is one strategy to combat a recession.
By spending more than it collects, the government injects additional money into the economy, which can help stimulate demand and economic activity. During a recession, budget deficits can result from increased government spending on public projects or reduced taxes to influence economic growth. The goal is to:

• Kickstart demand in the short term, allowing more money to circulate through the economy.
• Support job creation by funding projects or providing subsidies to businesses.
• Foster consumer confidence by ensuring financial stability and availability of goods and services.

It is important to note that while budget deficits can be beneficial short-term during recessions, they must be managed carefully to avoid potential long-term financial issues, such as increased national debt.

Economic Growth

Economic growth is the increase in the production of goods and services in an economy over a period of time.
It is often measured in terms of GDP, which accounts for total domestic output.
Strong economic growth leads to increased employment opportunities, higher income levels, and improved standards of living. Policymakers aim to achieve steady economic growth as it indicates a healthy and prosperous economy. During a recession, economic growth slows or contracts, prompting government intervention. By implementing fiscal policies like running budget deficits, the government seeks to:

• Spur investments in infrastructure and technology, boosting productivity and output.
• Encourage private sector confidence to resume hiring and expansion efforts.
• Enhance public services and programs, improving overall quality of life for citizens.

Ultimately, the goal is to transition from a struggling economy to one with robust growth, ensuring long-term sustainability and prosperity for its citizens.