Federal Stimulus
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In times of economic recession, macroeconomic theory states that stimulus is necessary to keep the economy moving forward and prevent a deflationary spiral. This can be achieved in several ways. Federal stimulus can come in the form of lowered federal interest rates, tax cuts, or direct government spending. In our recent recession we have used all three.
Lowered federal interest rates cause the money supply to increase and lower the cost of capital. This encourages borrowing and spending in order to keep the economy moving. The drawback to this method can be inflation if the interest rates are not increased once the recession is over.
Tax cuts can also stimulate the economy by putting more money in the pockets of the consumer and encouraging spending. The drawback to this method can be what Keynes called the "Paradox of Thrift". Often, tax cuts are saved and not spent. Saving and paying down debt is good for the individual, but bad for the whole. When everyone is saving, there is not enough spending to keep the economy moving. Higher income brackets tend to save more than lower brackets, as the lower brackets tend to spend a much higher percentage of their wages, especially in times of recession.
The last form of federal stimulus is direct government spending. This is beneficial in two ways. When an economy is in recession the government becomes the spender of last resort. In direct government spending, the government can spend money in infrastructure upgrades, long term projects and research and development. This achieves the result of both direct employment and leaving us with tangible assets from the spending. This can be roads, airports, rail lines or science, engineering advancements. These assets set the stage for future economic growth.
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