General increase in prices of good and services (inflation). Increase in disposable income causes aggregate demand to be greater than aggregate supply and in applying the law of demand where demand is high and supply is low price increases. Therefore individual household will pay more for goods and services. Hence tax rebate will cause an increase in nominal income but real income may remain unchanged. Increased cost of borrowing – such an expansionary policy by government will cause interest rate to rise. Therefore individuals who seek fund from banks will now have to pay more in term of interest on loans and this make borrowing costly.
In addition individual servicing loans and mortgages may be required to make additional payment in term of interest. Loss to bond holders – interest rate has an inverse relationship with bond price. 4 Therefore tax rebate causes an increase in money supply which in turn forces interest rate to rise. This will cause bond price to fall and investors who want to sell their investment may experience losses. As tax rebate is aimed to benefit low- income earners they are more likely to spend increase in income on consumption rather than saving.
As seen in year 2001 tax rebate increased consumption by 0. 8% in the first quarter and 0.6% in year 2002. therefore the program may not achieve the desired objective since increase in income will be used to increase consumption of luxuries and putting in mind that much of the goods are imported from abroad then the country may not achieve economic growth. The other program adopted by government includes the bail out plan. Through this plan the government aims to assist firms with liquidity problems. This is usually applied to companies which the government think are critical to economic development hence bankruptcy of such firm could influence the country both socially and economically.
For instance some firms which has benefited from the program include the Lehman brothers and AIG. The government expect to spend $700 billion in it bail out plan and already about $ 380 billion has been spent though no any significant change has been seen in the economy (shiller, 2008). Benefits of the bail out plan Availability of credit – banks lacked sufficient reserve to give loans to businesses and individual. This meant that business could not grow as there was no capital available for expansion. On the other hand consumption decreased since consumers could not access credit from financial institution.
5 Therefore when more fund are channelled to financial institution they will be more willing to advance credit to borrowers hence business will be able to increase output by employing more input such as labour, material and capital. This will help to reduce unemployment in the country and facilitate economic growth. On the other hand consumers will be able to spend more and in the long run aggregate demand will increase forcing supplies to increase output and this will solve the problem of unemployment and stagnation in the economy (Reynolds, 2009).
avoid unemployment in the country- many workers have already lost their job due to current recession and if more companies are allowed to go bankrupt then they rate of unemployment will increase and this is a burden to the economy as in increase the dependency ratio and also more people will be applying to the government for unemployment benefit and considering that the budget is in deficit it may force the government to cut expenditure on key development project slowing the economic growth.
Cost of bail out plan The government is using tax revenue to bail out private institution while such fund should have been used to improve the people’s welfare. The bail out plan directly benefits large firms while medium and small enterprises were also affected by the crisis. Therefore it does not seem logical to bail out institutions which were responsible for the crisis while leaving the majority who did not benefit from profit generated from toxic assets.
In addition the bail out plan has caused the government to borrow from abroad to fill the financing gap thereby increasing the government debt (Paul, 2008). 6 Conclusion Though the government has employed several program in tackling the current crisis no significant change has been observed in the economy as most companies recorded reduced earnings in the first quarter of 2009 and the bearish trend continues at the stock market.
If the gloomy situation in the economy remain then the government may need to change it program.
Felton, A. (2008). First global financial crisis of the 21st century: a voxeu. org publication. [S. l. ], Centre for Economic Policy. Paul krugman, Bad ant-stimulus arguments, New York Times, December 22, 2008. Reynolds, J. L. (2009). Bubbles, bankers & bailouts: the global financial crisis and how you can survive it. Vancouver, Douglas & McIntyre.