Assume that consumers in economy ZYX spend, on average, 80% to 90% of any new (a
ID: 1094890 • Letter: A
Question
Assume that consumers in economy ZYX spend, on average, 80% to 90% of any new (additional) disposable income to purchase goods and services. Based on a simple 3- sector Keynesian type economy, this might suggest a government expenditures multiplier in the range of 5 to 10, and a tax multiplier in the range of -4 to -9. In this country, the Obama "stimulus package" of some 830 Billion (2009 ARRA) produced nothing even remotely resembling such income increasing results.
The question: Explain. In short there seems a very significant divergence between "the theory" and "the reality" regarding the effectiveness of fiscal stimulus. How does one account for that?
Explanation / Answer
US Economy was hard hit by the Economic Recession during the 2008. It continued and spread to other parts of the world. Main reason behind the recession was fall in the demand due to subdued sentiments and reduction in investment in economic activties. Govt annouced the fiscal stimulation package to deal with the recession. But the it could not reduce the unemployment rate to 5 % as envisaged by the expert and economists given the higher consumption expenditure or MPC (Marginal Propensity to consume)
Here came to fore the fact about the difference between the theory and effectiveness of fiscal policy in dealing with recession. Stimulate package announced by the govt was sufficient to reduce the unemployment to 5 % level but the leakages in the investment pushed the investment to more lucrative destinations such as Asia and other emerging economies. It reduced the impact of multipliers in US economy. Further, the investment could not pick due to the subdued investors sentiments.
All these reasons contributed towards the ineffectiveness of Fiscal policy.