Demand Side Policies and Effects on Recession
Recessions are a normal part of the business cycle, but they can be very devastating to households. The economic meaning of a recession is two consecutive quarters of negative gross domestic product (GDP) growth. Other factors like unemployment, home sales, investment, and production are also considered. Recessions are declared by the National Bureau of Economic Research (NBER). Many recessions are shorter one year in duration and their impacts are minimal. Depressions are usually longer lasting and can be more economically destructive than recessions. In 2008, the world experienced what would be called “the Great Recession” and it affected millions of people around the world. (Prisecaru, 2014)
Demand side policies can be used to recover from recessions. Demand side policies target aggregate demand rather than dealing with aggregate supply. Demand side policies are made up of two sub policies: fiscal and monetary.
Fiscal policy is when the government tries to change the economy by adjusting revenue and spending. Revenue is increased or decreased by adjusting taxes. Spending is adjusted by changing government expenses and programs.
Cutting personal income taxes allows households to increase the amount of money they have available. This should increase consumer demand because of increased sale of goods. However, many consumers may not spend more money and instead increase their savings, especially if the economic future is uncertain.
Cutting corporate taxes allows firms to decrease their expenses, which can allow for more investment spending. Lower corporate taxes also allow firms to survive longer if the economy enters a recession due to lower expenses.
Lowering taxes will increase the countries deficit because government revenue is tied to taxes. In the long run, lowering taxes will cause the government to borrow more and run a high deficit. In the short run, lowering taxes will increase aggregate demand. (Rittenberg & Tregarthen, 2009)
Government spending can be lowered by cutting funding for programs. This can be detrimental during a recession because elderly and unemployed people may require unemployment benefits to survive a recession.
During recessions, government spending should be increased. This includes creating jobs through public projects like building roads or bridges. Increasing social program availability is also helpful during a recession.
By increasing government spending, aggregate demand is shifted to the right. This, along with tax cuts, allow the economy to recover faster.
Monetary policy is a tool of the Federal Reserve. They are responsible for setting the interest rate. Interest rate is very important to the economy. It is so important that the Federal Reserve operates independently of the president’s administration to prevent manipulation of the monetary policy.
A low interest rate incentivizes spending and investment. Firms and consumers can borrow at favorable rates which allows them to build more factories or purchase more houses and cars. All these factors lead to an increase in aggregate demand. High interest rates make it more difficult for firms and consumers to borrow money and therefore can lower aggregate demand. (Rittenberg & Tregarthen, 2009)
During the Great Recession, Congress approved the American Recovery and Reinvestment Act (ARRA) in early 2009. Taxes were cut by $288 billion, government benefits were allotted $224 billion, and $275 billion was allotted to job creation. The intent of the ARRA was to increase aggregate demand, as described above. (Amadeo, 2019)
The ARRA managed to grow the GDP by 1.5% in the third quarter of 2009 and 4.5% in the fourth quarter. The stimulus was a success overall. A portion of the package was a tax rebate that many consumers were not aware of. As a result, consumer spending may not have been efficiently increased. (Amadeo, 2019)
Another issue with the ARRA was the time delay for implementing the package. Several months had passed since the NBER had declared a recession. By the time the ARRA had been approved and disbursed, much of the damage was already done to the economy. However, the economy did recover faster as a result.
Demand side policies can help economies recover from recessions. These expansionary fiscal and monetary policies increase aggregate demand which allow enough recovery.
These lessons are important because eleven years after the Great Recession, economists are ever alert to the next recession looming over the horizon. While economists never know when the next dip in the market cycle will occur, certain events such as the current trade war seem to make such dips more likely. When the economy does enter recession, it is important that economists and politicians understand and properly utilize fiscal and monetary policy to minimize the duration of recessions.
Amadeo, K. (2019, August 7). Did Obama’s Stimulus Plan Work? Retrieved from https://www.thebalance.com/what-was-obama-s-stimulus-package-3305625
Prisecaru, P. (2014). The Dilemma Of Demand Side Policies Versus Supply Side Policies For Relaunching Capitalist Economies. Global Economic Observer, 2(2), 28–36. Retrieved from http://search.proquest.com/docview/1680217665/
Rittenberg, L., & Tregarthen, T. (2009) Principles of Macroeconomics. Irvington, NY: Flat World Knowledge.