By Cedric Welsch
This has always been the classic tradeoff that economists and governments need to decide on, in their attempts to stimulate economic growth. While, fiscal policy is mainly related to taxation and deficits, monetary policy is concerned with management of money supply and setting interest rate levels. The issue of inflation needs to be kept in mind, while developing the monetary policy.
Fiscal policy can be effectively used to influence economic growth by appropriately changing tax levels in the economy. Tax rate changes can also be done in a way such as to target certain sections of the economy or sectors by making specific changes in taxes. Thus reducing taxes on incomes of individuals can automatically increase the disposable income at the hands of consumers and encourage them to spend. Tax benefits for buying houses can help boost the housing sector. Similarly, fiscal policy can be used to stimulate various sectors of the economy. Monetary policy on the other hand has an overall impact, and by changing conditions that impact money supply, aggregate demand in the economy can be influenced.
The US President seems to now be engaging the fiscal policy lever to provide further stimulus to the US economy. Obama’s new agreement to extend the Bush era income tax cuts is likely to increase disposable income at the hand of consumer and could help provide a stimulus to consumer spending and the US economy. This move could also reduce the pressure on the US Fed with regard to its $600 billion bond purchase program to keep interest rates low. Effectively, fiscal policy is being used to stimulate the economy over monetary policy tools. Obama’s proposal sets the estate tax at the top rate of 35 percent, while extending aid for the long-term unemployed by thirteen months. The proposal would also allow companies to deduct the full cost of investments in equipment next year. Economists are of the view that this fiscal policy maneuver could raise US GDP next year by as much as 0.5% to 3.1%.
The income tax cuts is applicable to all wage earners and would result in savings of $800 for those with incomes of $40,000 and up to $2136 for those with incomes over $106,800. The Obama proposal is likely to cost the US government nearly $120 billion in what would have otherwise been collected as taxes. Effectively, US consumers would have an additional $120 billion to spend.
Assuming that the program gets a green signal and does not get caught in political crossfire, it is likely to boost demand in the US economy and should result in a reduction in unemployment gradually, setting in a positive and hopefully a self sustaining growth cycle. Economists are of the view that the program could lead to an increase in employment by as much as 2.7 million and bring down the unemployment rate to 8.7% from the present high of 9.8%.
An increase in demand in the US is likely to have ripple effects for economies around the world and with the US being the largest importer, Obama’s plan is likely to touch the lives of people around the world.
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