Fiscal Policy

Paper Instructions

This is for Discussion Board – write your response based on the simulation results. Share your experience in the simulation. What strategies did you pursue? Were you successful in reducing the debt?
In your opinion, is a high national debt a problem for future economic growth? What is the ideal debt-to-GDP ratio? Research academic sources or refer to the information available through the simulation to support your opinion.
Government spending increases national debt and can cause a crowding-out effect. Explain what the crowding-out effect is and why it’s considered a negative effect of increased government spending. Use information from the textbook to support your analysis.

ANSWER

Fiscal Policy

I was able to stabilize the debt in the short term and bring down the debt in the long term. In order to achieve this, I strived to broaden the tax base. With some tax revenues falling, it is important to introduce new taxes to boost the level of revenues, which is used in settling the debts. A debt ceiling was also put in place. Clearly, the strategies were successful in reducing the debt from 79% to 51% (IMF, 2010). The high national debt is indeed a problem for future economic growth. It increases interest payments, which crowd out spending on the other priorities. It exerts more pressure on the interest rates across the economy, and this includes auto loans and mortgages.

A high debt to GDP ratio is not good for a country, given that a higher ratio points to a higher risk of default. A study that the World Bank conducted affirms that a ratio that goes beyond 77% for an extended period of time may have a negative impact on the growth of the economy (IMF, 2010). There is a need that governments uphold the principle of fiscal sustainability.

Crowding out effect is an economic theory, which argues that the rising public sector spending is likely to drive down or even do away with the private sector spending. As the national debt grows through increased borrowing, there is more chance that the government’s competition with the private sector for the loadable funds will escalate the interest rates, and this may subsequently crowd some of the private bond issuers out of the market.

Reference

IMF (2010). “From Stimulus to Consolidation: Revenue and Expenditure Policies in Advanced and Emerging Economies,” April 30 (pp7-8).

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