Introduction
The US government has formulated a number of macroeconomic policies to stimulate the country’s Gross Domestic Product (GDP) as restoration strategies. Some of the macroeconomic policies that the US government has considered include increasing the level of spending in defence, education, and infrastructure. According to Greg (2009, 2), increasing the level of spending is one of the strategies that is used to restore an economy from recession. In implementing these policies, the government increased the amount of funds appropriated to these expenditure items. However, 18 months later, the growth in GDP was only by three quarters of the expected result. This situation can be associated with the following factors.
Increase in inflation rate
Government spending is a component of the aggregate demand. The aggregate demand consists of consumer expenditure, tax, investment and government expenditure and the net exports. By increasing the amount of government spending through education, defence and infrastructure, money supply increases in the economy. An increase in the amount of money circulating in the economy has an inflationary pressure. This is due to the fact that the aggregate demand increases at a higher rate than the aggregate supply. This means that there is a general increase in the price of commodities resulting into a reduction in the size of consumer spending. This culminates into a reduction in the multiplier effect and hence the aggregate demand is not stimulated as expected.
Increased crowding out effect
An increase in government spending results into a crowding out effect. Crowding out refers to the reduction in private investment as a result of an increase in the interest rate. As a strategy to restore the economy through increased government spending, the US government resorted to borrowing. According to Greg (2009, 1) the government borrowing was from both individual and institutional investors such as car companies, banks and home owners. Greg (2009, 4) asserts that the increased borrowing has resulted into an increase in the US ratio of debt to GDP to a high of 41%. An increase in borrowing from individual and institutional investors tends to increase the market rate of interest and hence the cost of capital. This makes the private investors to shy away from investing in the various sectors of the economy. This is due to the fact that investments are sensitive to the interest rate. The effect is the aggregate demand is not stimulated as expected. This is due to the fact that there is a reduction in the volume of output from the private sector.
Crowding out due to reduction in resources
In addition, increased government borrowing is resulting into a crowding out of the private investors through a reduction in the resources. This is due to the fact that the resources available to the private sector in form of loans are significantly reduced. The effect is a reduction in the volume of output from the private sectors.
Conclusion
During recession, increasing government spending is one of the macroeconomic policies that is considered by various governments. This is due to the fact that it results into a multiplier effect thus stimulating the rate of economic growth. However, the rate of economic growth is reduced by other factors such as an increase in the rate of inflation which reduces consumer spending. In addition, increase in government spending crowds out private investments due to an increase in the rate of interest. Crowding out of the private investors also results from the fact that there is a reduction in the amount of resources available to private sectors. The effect is that the economy is not stimulated as expected through increased government spending.
Reference
Andrew, M.(2009).The potency of government spending and taxation. Web.
Greg, I.(2009). We are borrowing like mad: can US pay? The Washington Post. Web.