Policies to Deal With Economic Crisis

Readers Question: Due to international economic crisis, how can unemployment in a developing economy that depends on revenues from oil be solved through the use of fiscal policy, could monetary policy be used as well?

An International economic crisis could involve a fall in economic growth and the prospect of recession.  In this case fiscal policy could involve an increase in  Government spending and lower taxes. Lower taxes should increase consumer disposable income and therefore help increase Aggregate Demand (AD). If the government is successful in increasing economic growth, it should lead to higher levels of employment. As firms produce more they demand more workers.

The Government spending could be used on sectors other than the oil sector to try and encourage greater diversity in the economy. The best type of government spending would involve infrastructure improvements, such as building roads. As well as increasing AD, this may also help increase the productive capacity, which is beneficial for long term growth and development of the economy.

The drawback of fiscal policy is that developing countries may already have large public debts and therefore struggle to raise sufficient borrowings.

Fiscal policy can also be ineffective in increasing AD, for various reasons. See: limitations of fiscal policy 

Monetary policy could also be used to increase AD.Lower interest rates would make borrowing cheaper, this should encourage consumption and investment. In the long term this may lead to higher growth.

The drawbacks to cutting interest rates may involve

• Lower exchange rate
• Time lags involved
• Consumers inelastic response to lower rates

See also: Problems in recovering from recessions