Govt expenditure that we hear of in the Keynesian framework included expenditure on public works, infrastructure and industrial production so as to stimulate or trigger the multiplier..at the same time facilitate the ground for private domestic investment (I). What motivates private investment? Definitely the profit motive, but also the joy of creating and controlling production and the 'animal spirits'...which symbolises the thrill of risk taking -- Keynes said 'knowing better than the market what the future will bring forth.'
Interest rates are not the only stimulus to investment...this is similar to the fact that price of a commodity is not the only reason why people buy (or not buy) it. Interest elasticity (responsiveness) is another issue we looked at today w r t the 'liquidity trap'. If investment is interest in-sensitive, then changing interest for borrowing or lending purposes will not work as stimulus. What stimulates I in the liquidity trap mode? The reason one reached such low levels of interest rate is in an attempt to stimulate investment. But investment did not respond..What will it take invt to restart? Let us bring in Keynes' G here. He says..one way to stimulate pvt I is to help incentivise I with duty cuts, waivers, exemptions that help the private enterprise reduce its cost of production. This will help it reduce the final price it offers to the customer that may in turn help increase demand for product..(Whew!!! heavy)
The other way is to make G the source of expenditure (public projects). What is the ill-effect of this route? We call it 'Crowding out'. What is this effect? When the govt decides to incur expenditure, it comes in direct conflict with the private enterprise trying to borrow..and this may in turn reduce the excess liquidity and raise interest rates. Now the coming in of govt expenditure is fine..the question we need to ask is what is the purpose of this expenditure? Was it on conspicuous govt excesses or was it on works that had abilities to create jobs and lead to demand generation. If the answer is yes..it may actually help private enterprise revive in the next cycle. The second effect is that with the rise in interest rates, idle household saving may move into productive investments and the fund crunch may be a very short term phenomenon.
One question - is it better to raise disposable incomes of people or reduce corporate taxes to stimulate an economy in recession? The answer to this question is important because it leads to different effects on the Demand generation process. Excess money in people's hands may put undue pressure on prices of the (limited) goods. While surplus spending potential in the firm may help increase production and thereby jobs and the virtuous cycle. If the economy's problem is inventory pile up and no demand --- give money to people. Will they spend if taxes fell for them or would they also postpone consumption? In order to stimulate consumption, there should be disincentive to saving or a favourable business environment. So the govt needs to make sure that the private I is stimulated simultaneously so that people's confidence grows and they spend.
One last question (this one I will not answer) - Why is a bail-out package different from a fiscal stimulus? If I made sense to you thus far..you will have this answer...Keep thinking and reading!!
Bail-out package means - monitory support provided by the government to a particular sick unit (that is too big, big enough to bring down the economy) in order to bolster it to survive; so as subsequently it can sustain the credit shocks, and keep intact consumer confidence to some level. In the recession time US Federal reserve infused $ 700 Bn bail-out packages for various banks (BoA, Citi Bank, etc.) and financial institutions (Goldman Sachs, JPMC, Morgan Stanley, etc.) and auto giants (Chrysler and GM). A complete list you may find :http://www.usatoday.com/money/economy/tarp-chart.htm
ReplyDeleteOn the other hand, fiscal stimulus intends to support a particular sector, whose condition got worsen due to economic downturn and continuation of what may lead to massive unemployment caused due to clogged production. Stimulus packages can be in the form of (a).Tax reduction, (b).Duty reduction, (c).Subsidies, (d).Tax refund, (e).Export incentives, etc. The highlights of the first stimulus package declared by GoI can be read here : http://www.dnaindia.com/money/report_highlights-of-india-s-fiscal-stimulus-package_1212043
The highlights of the first stimulus package declared by GoI can be read here : http://www.business-standard.com/india/news/fiscal-stimulus-ii-eases-india-inc%5Cs-access-to-money/345084/
During the recession period various governments announced single/multiple stimulus packages (India, UK, Australia), but only a few governments declared bail-out packages where liquidity was an extremely serious concern (US, UK).
in addition to what tapan said i think that the bailout packages are more specific in nature.they are given as a rescue to some industry or firm that is suffering.so, firms night not use to for investment purposes and may use it for survival.
ReplyDeletethe fiscal stimulus such as tax cut is for the entire economy and is more uniform in nature.
adding further bailout is something given in bad times like 60000crore loan waiver scheme to decrease suicide rates of farmers so bailouts may or may not increase future production and investment while fiscal stimulus is to increase future investment if companies are not producing or not investing they will not get stimulus which is not in the case of bailouts. so bailoutrs are rarely given government tries on for fiscal stimulus first
ReplyDeleteIncreasing investment can lead to 2 situations
ReplyDelete1) Investment increases so production increases and also employement increases so there may be inflation. This is a case where investment,production and employement increases which lead to inflation
2) On the contrary we say sometimes investment increases so production increases so there may be pile up of the inventory and goods for sale so supply may be high which may lead to price cuts so this becomes a case of employement and investment which may decrease inflation
i guess these situation depend on the country and the stage in economic cycle but can anyone please elaborate more on this i am doubtful when what will happen
also i had a doubt about GDP we consider only goods and services produces in a year in calculating GDP but then when we consider price of land i mean only after we construct something on it or we never consider. Ideally gains and investments on property like land should be included in calculating GDP???
@ Tapan~~~~ Bailout Packages doled out by the govt need not necessarily be in the form of monetary support a mere guarantee or support of the Govt is a reason enough for the public to have faith in the institution in question and to qualify as a bailout package. Further I am not very comfortable with the use of the word sick unit. The institutions under question were not sick in the true sense of the term but were over leveraged. No one predicted that the recession would come so soon and the failure of Bear Sterns and lehman brothers further aggravated the problem and triggered the so clled credit default swaps which were held by almost all major U.S banks that is why Alan Greenspan refers to Derivates as Fiancial Weapons of Mass Destruction and induced systematic risk in the financial system. Further Bail out packages need not necessarily be for too large to fail institutions. A whole range of lenders are covered under the TARP and the Obama Plan. Further I feel that failure of too big to fail institutions(CITI) cannot bring down the Economy. The Economy is too large a term to be used in the present situation. It can adversely affect the Financial System in the Economy which will in turn will have adverse impacts on the Economy. Failure of a few institutions cannot bring down an economy. The US is the epitome of all economic activity in the world. Further the real bailout package by the US Govt has not been begin. Currently what the Us Govt has done is bought an Equity Satke in the cos and that too at dirt cheap prices but the real bailout i.e Clearing of balance sheet and getting rid of toxic assets is the real bailout required by the govt. The govt is to buy toxic assets, credit card debts and all sorts of other assets from the balance sheet when the actual value of these is worthless. So the govt is about to be left up with worthless assets of these banks.
ReplyDeleteI would start by discussing the logic for bail out and fiscal stimulus.
ReplyDeleteThe identity says that savings must equate investment (talking in a global sense).For any govt. the goal is to expand both future and current income. With reference to this, the impact of bailout plan or a fiscal stimulus is the same- they reallocate resources(the borrowed money)from one place to another.
Bailouts and stimulus packages are like dropping mannah in the way of hungry (the unemployed, however, the irony lies here is that they are themselves funded by taking a debt/printing money/raising tax (the recessionary times leave the govt also a pauper). The point of concern here is that both of the stands help increase future income and on rare instances have an impact on the current incomes of individuals.
Bail out is a lifesaving drug given to an ailing sector/company (crucial contribution to an economy), assuming that on receipt of the same, the sector/company would independently flourish in due time, and start generating revenues as it used to.
Fiscal stimulus, as the word says, stimulates the stagnation that recession had brought to that sector, and brings in the necessary vibration that will put people to work, either directly on government investment projects or indirectly through the consumption and savings decisions of the recipients of government spending.
The bottom line is, both bailout and stimulus have similar ripple effects on the economy, which is felt sometime later. What happens at present is more of debt-more deficit...To quote Mam "Govt is just an excuse for whatever goes wrong with us". A bail out given, a stimulus granted, the sectors who'll receive them will again have govt as an excuse (this time to help them when they'd need her- productivity/innovation take a back seat) and the sectors who don't receive it will play the blame game. Thus the 'G' of govt 'now' are theoretical Gospels of Keynes, too rosy a picture to be true.
One line of thought >>
ReplyDeleteIn a liquidity trap situation govt. spending if increased leads to crowding out of private I leading to increase in interest rate and bringing liquid savings to some form of investment.
During recession times fiscal stimulus (eg tax cuts) could lead to saving glut as discussed in class, the need for bail-out or some form of govt spending is to boost net wealth (stock prices or mortgages from near half) and sentiments.
Govt borrowing by way of debt need to be financed by increased taxes some day or the other, this counters the whole "increase in net worth" argument to get out of liquidity trap at the cost of mounting debts (US=$1 Trillion approx).
Manish Patel
As already explained very neatly and elaborately bailout and fiscal stimulus (as the govt calls it) is not a cure . These two tools only adds to the govt debt which offcourse comes at the expense of resources like idle saving waiting to be put to use.
ReplyDeleteAs they have no immediate effect on the current income or resources ;they are just a way to employ resources from one use to other. These tools plan to enhance or ensure future income using more productive activities than the ones they replace. In this cycle govt acts as a mere facilitator of resources from one to another.
But I think ,as discussed in the class as well, if the govt’s infusion of money finds its way to the saving accounts (be it individual or corporate) then it’s a double blow we loose on investment(crowding out effect) and the consumption as well, as people are still saving forcing the consumption down . This could be a big cost to bailout or fiscal whatever one takes.
Well there could be an option:-instead of funding through own sources , have the foreigners finance the debt required by the govt. In this way govt would have the funds to infuse without reducing private funding available in the domestic system.
Vivek Chauhan
In short, fiscal stimulus lead to capital formation and creates new opportunities of employment to revive the entire economy whereas bail out is a monetary(generally)help rendered to a particular sector which can carry out its operations smoothly in turbulent times.
ReplyDelete