Leveraging Federal Budget Deficits: Stabilizing Economies During Recessions

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Table of Contents

Federal Budget Deficit from a Recession Can Stabilize an Economy
Adjustments in Wages and Prices: Short-Run to Long-Run Equilibrium
Marketable Pollution Permits vs. Command-And-Control System
Three Factors That Should Be Included in the GDP Calculations
Reference List

Federal Budget Deficit from a Recession Can Stabilize an Economy

A budget deficit is a shortfall in the government budget, whereby expenditures exceed income in a fiscal year. This scenario is experienced when the government cannot sustain its corresponding level of revenue required to support its budget (Hyman, 2011, p.491). A recession is experienced when there is slow GDP growth, increased unemployment, reduced housing prices, and slow business growth. Despite all these sounding exceptionally distressing, something significant comes out of recession; it helps in stabilizing the economy (Hyman, 2011, p.491).

To manage inflation, usually, the Federal Reserve tries to slow the economy without exacerbating the recession. To achieve this, the federal government lowers taxes, increases spending on social programs, or simply ignores the deficit itself (Hall, & Lieberman, 2009, p.349).

During the recession, tax collection drops and the government is unable to adjust its expenses immediately, which affects income generation, hence the deficit. Increased deficit causes increases in government expenditure on citizens as the unemployed are compensated – there are also welfare payments and food stamps (Hyman, 2011, p.491). Although these changes in revenue and expenditure increase the budgetary deficit, the measures concurrently manage the decreasing disposable income among citizens and households (Carbaugh, 2010, p. 298).

During a decline in economic activities, it is natural that the level of tax collection likewise plummets (Carbaugh, 2010, p. 298: Hyman, 2011, p.492). At this point, the consumption and expenditure are maintained at an above-normal rate thus maintaining an appropriate level of aggregate demand. As a result, the effects of the recession on the economy are lessened (Hall, & Lieberman, 2009, p.349).

The federal budget deficit causes expanded total spending, otherwise called aggregate demand, thereby causing short-term economic growth. Increased government spending directly expands the aggregate demand in cases where the deficit was because of government spending (Hall, & Lieberman, 2009, p.349). In the event of a budget deficit because of tax cuts, the increased spending among recipients who get tax cuts increases the aggregate spending.

Adjustments in Wages and Prices: Short-Run to Long-Run Equilibrium

The short-run microeconomics describes the period when prices are stagnant or do not change tremendously. When wages are sticky, a company’s costs will remain stagnant, as well. Sticky wages result in sticky prices and this hinders the normal economic mechanisms from causing demand and supply to equilibrium in the short-run (Gamber, & Colander, 2006, p.114). The short-run equilibrium helps in the identification of Real GDP produced by the economy when these conditions are true: sticky wages, sticky prices, and producers as well as workers’ misconceptions.

After a while, the wages and prices ultimately become changeable, the misconceptions subside, and the producers and workers gain accurate perceptions. When this happens, the economy moves from short- to Long-run equilibrium (Gamber, & Colander, 2006, p.114).

During the short-run period, the prices and wages do not react to changes in the economic situation. The prices are slow to conform to the adjustments (sticky prices), when this situation happens, it results in periods of shortages and surpluses. Sticky prices and wages thwart the economy from operating at its natural level of employment and prospective production (McEachern, 2011, p. 562). Before the short-run equilibrium is connected to the long-run equilibrium, the economy normally suffers inflation. The supply curve slopes in recession as the unemployment rate increases and there are low wages. At this point, the economy is at a level output that exceeded the potential output. As a result, the competition for labor and raw materials increases (Gamber, & Colander, 2006, p.114).

The prices and wages also continue to increase. As such, the short-run aggregate supply (AS) curve will continue to rise until the intersection with the Aggregate demand (AD) curve (Gamber, & Colander, 2006, p.114). In such an event, the short-run AS curve will continue to rise until when it intersects with the AD curve. At this point, the economy will have attained the long-run equilibrium (McEachern, 2011, p. 562). The AD then intersects the long-run AS curve, and at this point, the operation of the economy is at its potential output.

Marketable Pollution Permits vs. Command-And-Control System

The command and control systems for environmental protection mostly worked as a traditional approach where the regulating body commanded the desired behavior. The regulator imposes limits on emission amount for the polluters – these are emission standards. Controlling and enforcing compliance becomes the job of the regulator. The incentive for maintaining the standards is sanctions and penalties on the polluters when they fail to comply (Jenkinson, 2000, p.49).

Permits, licenses, and other authorizations are granted or withheld accordingly. The permits are linked to air or water quality standards, and the emitters are required to fulfill some specified conditions like complying with the code of practice, reducing the impact on the environment, and installing treatment plants among others. The regulators have a reasonable level of predicting pollution levels (Jenkinson, 2000, p.49). However, the method is ineffective and not sufficient in addressing many of the recent pollutions problems like disposing of solids, depletion of the ozone layer, managing climatic changes depend, and other waste management issues.

Tradable permits allow polluters to purchase ‘rights’ for producing pollution or the regulators can also sell these ‘rights’ to the emitters. Under the marketable permit system, the bodies or authorities charged with this responsibility determine the targets of environmental quality (Jenkinson, 2000, p.49). This scenario is defined as the allowable level of emission, and it is referred to as the ambient environment standard quality. It translates to the number of allowable emissions that can be released. The discharge rights are allocated to companies as permits where owners can emit a specified amount of pollution. By understanding processes regulators are involved in, companies can make adjustments to their emissions in a strategic manner (Jenkinson, 2000, p.49).

Looking at these two approaches, the pollution permits are less costly but cause more pollution because, conventionally, the firms causing emission can pay for them. However, in the command and control system, the regulator can manage the level of pollution allowed without compromise because of the payment made for the missions (Jenkinson, 2000, p.49).

Three Factors That Should Be Included in the GDP Calculations

Even though for a long time, the gross domestic product has been the most common measure for a nation’s economic success, some researchers have argued that it is not one of the best measures since it has many deficiencies (Banting, et al., 2001, p.35). To give it a better picture of economic value, the debate has caused some meaningful issues to be aired, which addresses human-centered conceptions. However, several alternative indices can help in addressing the inherent deficiencies in GDP (Banting, et al., 2001, p.35).

Human Development Index (HDI)

This UNDP’s measure is a composite statistic, which has gained wide use on the international scene by multinationals and international bodies for evaluating and ranking countries in terms of three principal indicators of social and economic welfare viz. health, income, and education (Cohn, 2007, p.85). The income element is used for adjusting the per capita GDP, and it is measured in international dollars at purchasing power parity (PPP) for inequality, where the incomes of nations, which exceed the world average, are discounted (Tremmel, 2009, p.125).

The index of health in this measure is the life expectancy at birth. Education achievement of the nation is measured by the weighted sum of literacy and gross enrollment rates in schools and colleges- two-thirds weight is assigned to the literacy sub-component (Tremmel, 2009, p.125).

Genuine Progress Indicator (GPI)

Unlike HDI, GPI is quite intricate. It consists of 51 indicators of economic wellbeing, income inequality, consumer debt, under-employment, degradation of the environment, crime, sustainable development, etc. the measure is based on the personal consumption expenditure element of the gross domestic product (Banting, et al., 2001, p.35). This component hence measures the changes in inequality instead of the absolute inequality levels as indicated by the Gini Coefficient and income distribution indices. The other advantage of this measure is that it factors in the costs linked to pollution, depletion of natural resources, accidents, crime, and other protective expenses like lost leisure time (Banting, et al., 2001, p.35).

In GPI, the dollar value for each is factored based on higher education, volunteering, parenting, and domestic work. Comparing GDP and GPI, the debate that policymaking and decision-making were appropriate in the 1950s, 60s, 70s, and inadequate today are sustained. GPI assesses progress based on a remarkably large number of indicators related to human welfare hence the quality of life – it is based on GDP consumption data.

Weighted Index of Social Progress (WISP)

This composite index consists of forty economic and social indicators of a country’s development, wellbeing, and human welfare in ten dimensions (Banting, et al., 2001, p.35). The dimensions include the environment, status of women, cultural diversity, welfare, demographics, education, defense system, health, social chaos, and economics. The economic sub-index takes into account GDP per capita, the external debt, the rate of unemployment, the GDP growth rate, as well as the Gini index inequality measure (Banting, et al., 2001, p.35).

Reference List

Banting, K. G., Sharpe, A., & St-Hilaire, F. (2001). The Review of Economic Performance and Social Progress: The Longest Decade. Montreal: Institute for Research on Public Policy and Centre for the Study of Living Standard, IRPP.

Carbaugh, J. (2010). Contemporary Economics: An Applications Approach. Armonk, NY: M.E Shape.

Cohn, M. (2007). Reintroducing Macroeconomics: A Critical Approach.Armonk, NY: M.E. Shape.

Gamber, E., & Colander, C. (2006). Macroeconomics. South Africa: Pearson.

Hall, R., & Lieberman, M. (2009). Macroeconomics: Principles and Applications. Ohio, Southwestern: Cengage Learning.

Hyman, D. (2011). Public Finance: A Contemporary Application of Theory to Policy. Ohio: Southwestern: Cengage Learning.

Jenkinson, T. (2000). Readings in Microeconomics. London: Oxford University Press.

McEachern, W. A. (2011). Economics: A Contemporary Introduction. Ohio: Southwestern: Cengage Learning.

Tremmel, J. (2009). A Theory of Intergenerational Justice. London: Earthscan.

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