The Effects of Fiscal Policy on Private Business Investment
In January, 2012, the McKinsey Global Institute published "Debt and deleveraging: Uneven progress on the path to growth." In the executive summary, the following observations were made about the state of investment spending in the United States (and the U.K.):
"Today, annual private investment in the United States and the United Kingdom is equal to roughly 12 percent of GDP, approximately 5 percentage points below pre-crisis peaks. Both business investment and residential real estate investment declined sharply during the credit crisis and the ensuing recession."
The authors identify six ‘markers' of successful recovery from a financial crisis. One of those markers is a credible plan for balancing the government's budget in the long-run. In their words, we need "long-term fiscal sustainability." Why is long-term fiscal sustainability important for today's economic growth? In particular, how would a failure to present a credible plan for balancing the government's budget in the long run affect private business investment? Explain fully, using the model of loanable funds you studied in Module 21. In your answer, address the following points:
- How does business investment foster long-run economic growth?
o Explain how economic growth occurs.
o Explain how business investment contributes to that growth. (Review the powerpoint about ‘Pointers for Writing Assignment 3' on the Writing Assignments link on Blackboard).
- Explain how interest rates influence the incentive to invest. Make it clear that you understand the logic - why does an increase in the market interest rate reduce the incentive to invest? This paragraph should comprise the bulk of your paper.
- Explain how large government budget deficits year after year will have an impact on the equilibrium interest rate using the Loanable Funds model presented in Module 21.
- Summarize in a concluding paragraph - why did the McKinsey Global Institute conclude that long-term fiscal sustainability is important for economic growth?