LCB/2356

1. 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.

2. There are two schools of thought on how the US government should deal with its current economic problems

1. 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.

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.

2. 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