Economics

When an economy is experiencing a recession, the government can close the recessionary gap through lowering of taxes a part of fiscal policy. Cutting taxes will have an indirect effect on aggregate demand curve since consumers will have more cash at their disposal. The consumers will use the money for consumption or investment and this makes the aggregate demand to shift to the right (McEachern, 2015). As a result, the recessionary gap will be closed and economic growth is spurred.

The assumption by classical economists is that prices and wages in a specific economy will be flexible and this forms a major basis of the entire model of an economy that is self-correcting. They assumed that since wages and prices will remain flexible, the aggregate supply curve over the long-term will be vertical (McEachern, 2015). The implication of classical approach is that the forces of the natural market driven by flexible wages , prices and interest rates would shift the economy towards growth in GDP and hence , eliminating the need for regulatory intervention by the government. A major point of disagreement between Keynes and classical economists involves the notion that wages and prices may not be flexible enough to provide full utilization of resources and at times business expectations would be so bleak that even smaller interest rates may not induce investment of consumers’ savings by firms (McEachern, 2015).

Given that there is an increase in tax revenues when economy is expanding and reduction of the same during recession, a forecast is necessary for a budget so as to monitor such changes during various phases of business cycle.  When government spending is more than tax revenues, there revenue does not match the revenue, and hence there is a deficit. In case the government expenditure falls below tax revenues, there is a supply in the budget (McEachern, 2015).

Since the 2008 economic recession, there has been an increase in federal debt in proportion to GDP due to the efforts by federal government to bail out the economy. The federal debt has risen to levels not seen during past recessions.

Reference

McEachern, W. A. (2015). ECON microeconomics (Rev. 4th ed.). Stamford, CT: Cengage Learning.