An economy is a place of exchange, production, distribution, and exchange, not only of products and services but also of social practices and discourses. By this, it means that in the economic realm, the production of each product is the basis of this economy, while the exchange of the products and services take place on the market. In simple terms, it is understood ‘as an association of persons who produce and utilize the resources.’ In the broadest sense, economics is ‘the study of how individuals and institutions interact to produce, provide, or manage the means for living’. There are many factors that affect the efficient running of the economy, including laws, economics, government, economy, finance and technology.
Any society, state or economy, whether developed or developing, has limited economic resources. In times of crisis, these become insufficient and lead to economic imbalance. Crisis is considered an unavoidable event in any economic system, since it brings about financial breakdown. For example, in the United States during the 2021 economic crisis, the government tried various measures to stabilize the economy and maintain economic growth, which included injecting cash into the economy.
One of these methods was direct economic intervention; for instance, the federal funds injection program, government spending, subsidies and other financial instruments were introduced to promote economic recovery. However, these measures did not have an enduring effect on the economy. Consumer spending, the driving force of any economy, also declined. Ultimately, the economy remained sluggish, with unemployment and inflation going rampant. This prompted the government to re-examine its fiscal policy and consider the impact of its actions on the economy. Several studies were conducted to evaluate the effectiveness of fiscal policies on the economy.
Based on the results of these studies, a variety of economic indicators including gross domestic product (GDP), employment data, industrial production and unemployment rates were studied. These studies came up with several findings regarding the relation between consumer spending, output gaps and economic growth. These findings primarily pointed towards the negative impact of high levels of household debt and slow economic growth on the economy.
High levels of household debt can reduce the potential growth of GDP. In addition, high levels of inflation can reduce the potential growth of GDP. In both cases, higher interest rates will reduce the real value of money. In the long run, this will reduce gross domestic product (GDP). In the short run, higher inflation will reduce the real value of money leading to slower economic growth.
On the contrary, lower levels of output gaps imply faster economic growth. Since companies are in turn forced to reduce the operational costs that are needed to run their business, they are able to provide greater value to consumers. Given that more goods are offered at lower prices, there will be an increase in demand for these goods leading to an increase in overall economic activity. A higher level of demand is associated with a faster rate of economic growth. Moreover, goods are sold when the supply exceeds the demand leaving ample room for the economy to make use of the extra supply.
Inflation is a phenomenon of market forces that are beyond the control of consumers or producers. The central bank is forced to control inflation as it can damage the economy. Inflation is a price-inelier situation that can occur under varying market conditions. When the supply exceeds the demand, the government may resort to various measures including currency devaluation and direct printing of money to control inflation. However, if inflation is too high and remains unchecked, it can result in the indirect erosion of the standard of living across the economy.
In a stable economy, there is a balance between supply and demand. In a turbulent economy, there is surplus production or available resources that is not being utilized. This is the reason why there is inflation because increased production does not translate into increased usage. To prevent the economy from being too dependent on scarce resources, the government uses various policies such as taxes and purchases of goods to ensure that the economy remains balanced.