Demand side policies (HL and SL)
Examination paper 2
This data response paper on demand side policies can be completed as a homework or class work exercise and should be completed in around 105 minutes. The question and mark scheme is based on the IB approach to setting paper 2 data response questions. The question is based on data and text that the students need to use to answer the different sub-questions.
Canada can't spend its way out of recession, says Fraser report
Trying to kickstart the Canadian economy into recovery from the COVID-19 recession through federal and provincial stimulus spending will fail, warns a new report by the Fraser Institute.
The result will be weak economic growth, rising unemployment levels and substantial increases in already soaring government deficits and debt, thus prolonging the recession, according to the study by the fiscally-conservative think tank,Is Fiscal Stimulus an Effective Policy Response to a Recession?
Study authors Jake Fuss and Tegan Hill say economic research in both Canada and the U.S. indicates stimulus programs to recover from recessions built around such initiatives as subsidizing the construction of new infrastructure projects generate less than $1 of new economic growth for every $1 spent by governments.
By contrast, giving broad-based, long-term tax relief to individuals and businesses generates up to $5 of economic growth for every $1 spent.
“In the coming months, as governments contemplate trying to kickstart the economy with more spending, they should recognize that evidence indicates (stimulus spending) is ineffective and results in more government debt,” said Fuss, potentially making things even worse.
The Fraser Institute study does not classify the $169 billion the Trudeau government is spending on programs like the Canada Emergency Response Benefit, which provides $2,000 a month in income support to people who have lost their employment because of COVID-19, as stimulus spending.
“The federal government’s spending up to this point is largely an emergency response to COVID-19, including income stabilization measures, in an effort to help Canadians who lost jobs or work hours due to the lockdown,” said Hill.
The Fraser Institute’s concern, she said, is that as federal and provincial governments shift their focus from emergency funding to economic recovery, they will turn to inefficient and costly stimulus initiatives.
“Before implementing any fiscal stimulus package,” Hill said, “policy-makers must consider the potential implications on both the economy and government balance sheets, particularly as governments across Canada face large deficits and mounting debt.”
The Fraser Institute study concludes the best way to speed up Canada’s economic recovery coming out of the COVID-19 recession is through deficit-financed, broad-based tax cuts, paid for by reducing government spending over the long term, as opposed to deficit-financed stimulus programs, paid for by increased government spending and higher taxation over the long term. The institute also states that where increased government is necessary is in supply side policies, leading to ‘increased productivity and increased investment in research and development'.
“Past history suggests that stimulus (spending) will not improve the Canadian economy and may even be a detriment to it,” the study concludes, while “fiscal stimulus based on tax cuts is ‘much more likely’ to be growth enhancing.”
Parliamentary budget officer Yves Giroux predicted last week the federal deficit this year will hit $256 billion and the worst decline in economic growth since the 1981-1982 recession.
On Wednesday, Fitch Ratings, one of the three major U.S. credit agencies — the others are Moody’s and S&P Global — downgraded Canada’s credit rating from AAA to AA+ because of the amount of new debt the government has taken on to fight the COVID-19 recession.
The rating agency said it still considers Canada’s long-term economic outlook to be “stable.”
Prime Minister Justin Trudeau has promised to give Parliament and Canadians an economic “snapshot” of the country on July 8.
But he has added it won’t be a full budget, or even an economic statement, because there is still too much global uncertainty about the long-term global financial impact of COVID-19.
Original article accessed from the Toronto Sun on 29th December 2020.
Macroeconomic data for Canada (table 1)
|GDP $ billion||Unemployment %||Inflation %||Current account $B||Fiscal balance $B|
(a) Define the following words from the passage:
i. Recession (line 1) [2 marks]
ii. Unemployment (line 4) [2 marks]
(b) i. Calculate the % change in the rate of economic growth and unemployment for Canada in 2020. [3 marks]
ii. The growth of which type of unemployment is likely to be represented by the rise in the nation's unemployment rate from 5.5 to 8.5%. [2 marks]
(c) Explain using an appropriate diagram why the covid-19 pandemic will have caused the Canadian economy to fall into recession. [4 marks]
(d) Provide two reasons why the government deficit might have risen to $256 billion as a result of the economic problems facing the country? [4 marks]
(e) Explain using an AD / AS curve the likely impact of stimulus policies designed to recover from recessions 'built around such initiatives as subsidizing the construction of new infrastructure projects.’ (line 10) [4 marks]
(f) Illustrate using an AD / AS curve the impact of ‘supply side policies’, leading to ‘increased productivity and increased investment in research and development’. (Line 35-36) [4 marks]
(g) Using extracts from the passage as well as your knowledge of economics, evaluate the view that the Canadian government cannot spend their way towards economic recovery. [15 marks]
The question and markscheme are available as a PDF file at: Demand side policies