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Government Spending

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Fiscal Policy in the United States

In 2008, the economy of the United States was hit by the deepest recession since the Great Depression of 1930s. Over several months, millions of jobs were lost. The recession had a substantial adverse effect on the living standards of Americans.

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In January 2009, the U.S. Congress passed the American Recovery and Reinvestment Act (American Recovery and Reinvestment Act, 2009), which was then signed by the President of the United States. The primary goals of the Act were creating and saving jobs, providing relief for families, protecting the health care system from the impact of recession, and investing into the national infrastructure. The Recovery and Reinvestment Act increased government spending by about $500 million and involved cut taxes for low- and moderate-income households by about $287 million (American Recovery and Reinvestment Act, 2009).

The Expected Impact of the Increased Levels of Government Spending

Theoretically, according to the basics of Aggregate Supply Aggregate Demand Model (AS/AD Model), both increased government spending and tax cuts stimulate aggregate demand and cause the AD curve of the model to shift right. In addition, the tax cuts are also expected to stimulate supply (Evans, n.d.). Consequently, both measures are likely to have a positive effect on the capacity utilization rate and hence on the real GDP. The unemployment would be reduced accordingly. As for the effect on inflation, it depends much on the situation at the starting point. If the measures are taken at the lowest period of the recession, when the capacity utilization rate is relatively low, the increased spending is not expected to generate a substantial increase in inflation rates. Even the budget deficit seems to have some immediate stimulating effect on the GDP growth, though it is not an established view among economists (Evans, n.d.). In the long run, though, budget deficit leads to the increase in interest rates, which have a complex effect on the supply and demand curves (Evans, n.d.).

The above logic underlying the AS/AD Model is disputed by some researchers who note that the concept of stimulating effect of government spending was based mainly on multiplier estimations made for defense spending. There is not enough evidence that nondefense purchases would have the same effect (Barro & Redlick, 2011). Also, according to Barro and Redlick (2011), the tax cuts may reduce current GDP due to the decrease in labor input.

Increased Spending Versus Decreased Taxes

The real U.S. GDP grew slowly in 2010 after falling in 2008 and 2009. The contribution of government spending was a rather significant factor which slowed down the decrease in real GDP in 2009 (The Department of the Treasury, 2012); so the American Recovery and Reinvestment Act of 2009 achieved, at least partially, one of its goals. The positive effect of cutting taxes on GDP was not noticeable.

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The increase in government spending did not reverse the negative trends in the labor market. In fact, the rise of unemployment accelerated after the American Recovery and Reinvestment Act of 2009 had been signed (U.S. Bureau of Labor Statistics, 2014). As for the tax cuts, there were indications that a considerable number of jobs in the public sector were lost due to the fiscal challenges faced by state and local governments (The Department of the Treasury, 2012).

Both increased public spending and decreased taxes seemed to have an insignificant impact on the inflation rates, which remained moderate after the deflation of 2009.

The same may be said about the impact of spending and taxation policy on the industrial output. Industrial production in the US over the period of 2006 2011 fell by 2.5 percent (Bloom, 2013).

In the long run, however, growing government spending combined with reduced taxes contribute to the growth of the budget deficit and national debt, which in their turn have a depressing impact on the economy.

Issues and Risks of the Increased Budget Deficit

The extensive fiscal stimulation measures taken during and after the recession of 2008-2009 seriously aggravated the problem of the budget deficit in the United States.

As mentioned above, in the short run, budget deficit might have a stimulating effect. At the same time, it contributes to the increase in interest rates, which impede economic activity.

Another issue is the fast accumulation of the government debt that may lead to the technical default situation when the country is unable to finance the necessary outlays. The experience of several countries shows that such a situation leads to the collapse of the economy.

The proposed ways of overcoming the deficit also imply some risks and issues.

The health care costs, primarily Medicare spending, constitute of the most important factors contributing to the huge deficit of the U.S. budget. To address this situation, two basic options are discussed: cutting health care expense or increasing taxes (Bloom, 2013). Both options would have an extremely negative social effect.

However, according to the opinion of Douglas W Elmendorf, the eighth Director of the Congressional Budget Office, the country cannot continue to increase the budget deficit and accumulate debt. One of the main reasons for that is the aging of the population. The country has no option but to change their current fiscal policy (Elmendorf, 2012).

The minimum changes required for returning to the sustainability path would involve the cuts equivalent to about 25% of government health care spending and tax increases by about one-sixth as compared with the current tax burden (Elmendorf, 2012).

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