This equation makes it evident that governments affect economic activity ( GDP), controlling G directly and influencing C, I, and NXindirectly, through changes in taxes, transfers, and spending. On the right side are the sources of aggregate spending or demand-private consumption ( C), private investment ( I), purchases of goods and services by the government ( G), and exports minus imports (net exports, NX). On the left side is GDP-the value of all final goods and services produced in the economy. A basic equation of national income accounting that measures the output of an economy-or gross domestic product (GDP)-according to expenditures helps show how this happens: Governments directly and indirectly influence the way resources are used in the economy. Governments influence the economy by changing the level and types of taxes, the extent and composition of spending, and the degree and form of borrowing. Central banks indirectly target activity by influencing the money supply through adjustments to interest rates, bank reserve requirements, and the purchase and sale of government securities and foreign exchange. When policymakers seek to influence the economy, they have two main tools at their disposal- monetary policy and fiscal policy. More recently, countries had scaled back the size and function of government-with markets taking on an enhanced role in the allocation of goods and services-but when the global financial crisis threatened worldwide recession, many countries returned to a more active fiscal policy. With the stock market crash and the Great Depression, policymakers pushed for governments to play a more proactive role in the economy. Before 1930, an approach of limited government, or laissez-faire, prevailed. Historically, the prominence of fiscal policy as a policy tool has waxed and waned. In the communiqué following their London summit in April 2009, leaders of the Group of 20 industrial and emerging market countries stated that they were undertaking “unprecedented and concerted fiscal expansion.” What did they mean by fiscal expansion? And, more generally, how can fiscal tools provide a boost to the world economy? The role and objectives of fiscal policy gained prominence during the recent global economic crisis, when governments stepped in to support financial systems, jump-start growth, and mitigate the impact of the crisis on vulnerable groups. Governments typically use fiscal policy to promote strong and sustainable growth and reduce poverty. Governments use spending and taxing powers to promote stable and sustainable growthįiscal policy is the use of government spending and taxation to influence the economy. The effect of the speed of growth of GDP versus the growth of national debt on the debt-GDP ratio Implicit liabilities in the US: definition and examples spending promises (mostly in retirement plans and health coverage) made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics.5 min (1403 words) Read BACK T O BASICS COMPILATION (4) In extreme cases, rising debt may lead to government default (fail to repay), resulting in economic and financial turmoil The debt-GDP ratio: definition. Nations are "graded" (bond credit rating) according to the risk associated with purchasing their debt. (3) The bigger the debt (as a ratio of GDP), the greater the unease over the borrower's ability to pay, and the higher the interest rate that the borrower must offer in order to attract lenders. (2) Increasing debt puts financial pressure in future government budgets. Problems related to rising debt (1) Public debt may crowd out private investment spending - they compete for loanable funds, and interest rates might increase, giving disincentives for the private sector to invest. Public debt: definition refers to federal government debt held by individuals and institutions outside the government.
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