Should the government increase spending to get out of a recession?

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‘The government should not increase spending to get the economy out of recession.’ Discuss.

A recession is a terrible thing. Unemployment rates soar as firms close down, economic growth slows due to a lack of demand, and with consumption declining, desperate consumers seek help from the government to sort the economy out. One method of doing so involves a hefty fiscal stimulus, known in the trade as ‘government spending’. An increase in government spending was a method famously proposed by arguably the most influential macroeconomist of the twentieth century - John Maynard Keynes. His policies became known as Keynesian economics, and have notably been implemented in 1937, to assist Franklin Roosevelt’s New Deal program during the great depression1.  Keynes argued government should exploit its massive financial power to force the economy into submission and encourage economic activity2. Keynesian economists call this theory "counter-cyclical demand management," because it attempts to effectively control aggregate demand3.

How, then, does this theory work? Government spending consists of public sector pay, publicly provided goods (such as defence and the NHS), transfer payments and debt interest4. An increase in transfer payments – money taken from the rich, and given to the poor – will increase demand for the necessities in life, such as food and water. People on low incomes general have a high marginal propensity to consume, because more of their income is spent on goods and services need to survive5. Whereas the rich can safely have idle money in bank accounts, gathering interest, and still enjoy luxury goods like that new Mercedes Benz. Therefore, the accumulated revenue from taxation can be used to fund the lives of people on low incomes, in true Robin Hood style.

However, I sense a problem. The government does not have an infinite supply of money or materials, because as the basic economic problem states “there are finite scarce resources to satisfy infinite wants” 6. There are three main ways the government makes its money, discussed below7:

  • Taxes (indirect and direct), levied on income and consumption (e.g. VAT and excise duty),
  •  Borrowing from other governments,
  • Printing more money – coined ‘quantitative easing’.
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Therefore, in order to fund a government proposal, the necessary revenue has to be generated. You can’t buy a 30p apple without 30p8. The problems that arise from this are substantial. If the government raises taxes, ceteris paribus, consumption will decrease, as consumers have less discretionary income. The method seems counter-productive – why lower people’s real income to bring the economy out of a recession? This perfectly complements the argument that governments should not increase spending. In addition to the aforementioned problem, borrowing money seems like a viable alternative. Buy now, pay later. Increase economic activity now when it is ...

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