FISCAL STIMULUS: IS IT THE ONLY

SOLUTION TO REGENERATE ECONOMIES

Written by

Dillip KhuntiaDillip KhuntiaDillip KhuntiaDillip Khuntia

&&&&

Abani Kanta SahuAbani Kanta SahuAbani Kanta SahuAbani Kanta Sahu

Master of Finance & Control

Utkal University

Introduction

The world economy bleed heavily in 2007 which resulted in the worst financial crisis

since the great depression of 1930.It contributed to the failure of the key business, declining

in the consumer health and a significant decline in economic activities. Economics worldwide

slowed during this period as credit tighten and international trade declined. For that

government of different countries and central banks responded with unprecedented fiscal

stimulus, monetary policy expression & institutional bailouts.

As financial turmoil continues to better world economies, triggering the collapse of a

number of financial institutions, the bailout packages of different governments globally is

nearing the $3 trillion mark about three times the size of Indian’s economy. The US

government had moved the hiatoride $700 billion rescue plan in response to the deepening

credit crises. Containing a spate of billion dollar rescue plans, countries like UK, India,

Russia, European countries have also announced revival packages.

Ambulance Economics: - The Keynesian Approach

Ambulance economics is about the immediate, urgent temporary rescue process.

Keynesian theory that was never really called upon in Great Depression of 1930, seems to be

the only rescue called upon all over the World from China and Japan to the US and Germany

in the after math of global economic meltdown. Thus it is very much important that we

should analyze the effect of stimulus packages.

The Keynesian theory states that a fiscal expansion taking the form of expenditure on

in fracture, which is financed by the sales of bonds or other forms of public expenditure or

reduction in taxation , will lead to budget deficit, which will increase the public debt. The

increases expenditure relative to recession situation will give rise to a familiar multiplier

process, which will revive domestic output and employment and also consumption.

The theory also states that a country’s fiscal stimulus actually has three parts. The 1st

part is the discretionary stimulus, of which in investment in fracture is an important example.

The 2nd part consists of the automatic stabilizers. Here it is important to remember that these

stabilizers may actually be financed, they are not financed, and they would fail to stimulate

the economy. The 3rd part is government finance provided to rescue or assist the financial

sector. This will certainly increase the public debt, but may not directly lead to extra spending

and hence may not have an immediate stimulus effect. It will just help in reviving the

financial sector and hence the economy.

Benefits

It implemented properly, stimulus packages have may benefits, and they are

1. The cost of complete collapse of a financial system is incalculable for business and

for a nation. Thus it is almost lead to stimulate the economy by announcing stimulus

packages.

2. The fiscal stimulus leads to financial stability.

3. By taking away, the uncertainty about looming mortgage related losses, the stimulus

packages will pave the way for the financial institution to keep lending and get new

infusions of private capital. Indeed bailouts are very much crucial at a time when the

size of the problem is growing faster then bank’s capacity to handle it.

4. Fiscal stimulus also protects the economy from depression. It can also be said hare

that it there would be stimulus packages during the financial crisis in 1930’s it

wouldn’t have lead to great depression.

5. Prolonged and severe unemployment lead to loss of human capital in the form of

work experience and confidence that goes with it. But by the help of stimulus

packages the unemployment problem can be hedged and an important resource that is

human capital can be saved.

6. Financial crisis harms the capital market and inefficient capital market obstructs the

development of a country. But by the stimulus packages the efficient operation of

capital market can be assured and also the economic development.

The Skeptics

Though fiscal stimulus has many advantages, it is not free from critism.The

major agreement against fiscal stimuli is

1. If the economy is recovering what is the need for a stimulus packages. Perhaps it

would have recovered without the stimulus.

The central issue here is the uncertainty of success of stimulus packages.

2. It is also said that the bailout doesn’t address the core problems. It only deals with the

difficulties of financial institutions instead of dealing with main causes of meltdown.

3. So far it has failed to restore the flow of lending as per the expectation.

4. The bailout package has attached a limited set of restrictions on dividend increase,

share repurchasing and managerial compensation. In spite of these restrictions there is

no way to measure whether taxpayer money is being used to boost lending and at the

same time there is no obligation to make new loans.

5. If a government borrows to finance a deficit, the wise far seeing taxpayers will

anticipate that taxes will have to go up in future to repay this debt. They will then save

additionally to prepare for this event. Thus the total spending will not change. So the

objective of stimulus package that is to stimulate public expenditure will fail.

6. Fiscal expansion will crowd out private investment through raising interest.

7. Huge stimulus packages of developed countries may affect adversely the developing

and developed countries.

Conclusion

The arguments against stimulus packages can also be can also be challenged. One

can’t say that it is unnecessary to announce stimulus packages when the economy is

recovering or investor will not invest because they have to pay more tax in future. Thus it can

be concluded that ambulance (stimulus packages) should be called to hedge the drastic and

add impact ofcrisis and to catalyze the economic revival and growth.

Reference

⇒ The Economics Times

⇒ Business Standard

⇒ Report Of SCRC

⇒ World Bank Report

⇒ Report of IMF

⇒ Financial Express

⇒ Economy & Business

⇒ RBI Publications

⇒ www.google.com

⇒ www.moneycontrol.com

⇒ www.investopedia.com

⇒ Business Outlook