Free Essay

Fiscal Policy

In: Business and Management

Submitted By lizwheen
Words 1853
Pages 8
What is fiscal policy and how can it be used to manage the economy? Briefly describe the current UK fiscal policy, and comment on the effect it may have on the economy.

Fiscal policy is the use of government spending, taxation and borrowing to influence the level and growth of aggregate demand, output and employment. Aggregate demand (AD)= Consumption + Investment + Government spending + (Exports – Imports). Changes in fiscal policy affect both aggregate demand and aggregate supply. (Riley 2006) Fiscal policy is used to achieve macroeconomic objectives such as full employment, price level stability and sustained economic growth. Expansionary fiscal policy is an increase in government expenditures or transfer payments, or a decrease in tax revenue. A tax cut will increase AD because it increases households’ disposable income. The greater the disposable income the greater is the quantity of goods and services demanded and therefore the greater is AD. This will stimulate economic growth in a recession, which will shift the AD curve to the right. (Parkin, Powell and Matthews 2008)

The magnitude of the shift = expenditure multiplier x the increase in government expenditures. In the short run it will increase both Gross Domestic Product (GDP) and the price level. An increase in the price level will increase the money wage rate, which reduces the SRAS. The SRAS curve shifts left until in the long run real GDP = potential GDP at a higher price level. Contractionary fiscal policy is the opposite of expansionary fiscal policy, which through a decrease in government expenditures or transfer payments, or an increase in tax revenues, will shift the AD curve to the left.

The government expenditure multiplier is the amount by which a change in government expenditure on goods and services is multiplied to determine the change in equilibrium expenditure and real GDP that it generates. As government spending is a component of aggregate demand, aggregate expenditure and real GDP are affected when government expenditure changes. The change in real GDP induces a change in consumption expenditure, which brings an additional change in aggregate expenditure. The autonomous tax multiplier is the magnification of a change in autonomous taxes on equilibrium expenditure and real GDP. An increase in taxes decreases disposable income, which decreases consumption expenditure. Tax multiplier = marginal propensity to consume x expenditure multiplier. Because a tax increase leads to a decrease in expenditure, the autonomous tax multiplier is negative. The tax multiplier is less than the expenditure multiplier as a proportion of tax cuts are saved before spending. £1bn in tax cuts has a smaller effect than £1bn increase in government spending. The balanced budget multiplier is the multiplier that arises from a fiscal policy action that changes both government spending and taxation by the same amount so that the government’s balanced budget remains unchanged. Because the tax multiplier is smaller than the government expenditure multiplier, the balanced budget multiplier is greater than zero. Balanced budget multiplier = expenditure multiplier – tax multiplier. (Parkin, Powell and Matthews 2008) The multiplier effects of an expansionary fiscal policy depend on how much spare productive capacity the economy has; how much of any increase in disposable income is spent rather than saved or spent on imports, and also the effects of fiscal policy on variables such as interest rates. (Riley 2006) Automatic stabilizers are mechanisms that operate to stabilize real GDP without the need for explicit action by the government. They include those changes in tax revenues and government spending that come about automatically as the economy moves through different stages of the business cycle. If the economy is growing, people will automatically pay more taxes (VAT and income tax) and the government will spend less on unemployment benefits. In a recession the opposite will occur with tax revenue falling although increased government spending will help increase AD. (Pettinger) But automatic stabilizers do not actually stabilize. They just make fluctuations less severe. These stabilizers operate because income taxes and transfer payments fluctuate with real GDP. As GDP falls, tax revenue falls, transfer payments rise and the budget balance changes. (Parkin, Powell and Matthews 2008) Discretionary fiscal changes are deliberate changes in direct and indirect taxation and government spending to affect AD and stabilize the economy. The biggest source of income for the government is income tax.

The UK’s government spending each year takes up over 40% of gross domestic product. Spending by the public sector is broken down into three main areas: transfer payments, current government spending and capital spending. Government spending is justified on economic and social grounds. It provides public goods and merit goods, a safety net system of welfare benefits, necessary infrastructure, and it manages the level and growth of AD to achieve macroeconomic objectives. The Private Finance Initiative is a way of funding expensive infrastructure developments without running up debts. Rather than borrowing to fund new projects, John Major’s government and the Labour government that followed entered into long term leasing agreements with private contractors. However critics say that private finance is more expensive than public capital and that although the government saves in the short term, the country will pay more in the long run. (Riley 2006)

Changes to fiscal policy can affect the supply side capacity of the economy and therefore contribute to long-term economic growth. Increases in income taxes, for example, lower the net rate of return to private investment, making investment activities less attractive and lowering the rate of growth. It is hard to think of an influence on the private real rate of return and on the growth rate that is more direct than that of income taxes (Easterly 1993). Tax cuts increase labour market incentives and therefore increase aggregate supply. Capital spending contributes to an increase in investment across the whole economy. Lower rates of corporation tax and other business taxes might also be used as a policy to stimulate a higher level of business investment and attract inward investment from overseas. Research and development improve the international competitiveness of domestic businesses. (Riley 2006)

Some economists believe the supply side effects are large and exceed the demand side effects. Free market economists, while agreeing that supply side effects are present, believe that they are relatively small. They argue that lower taxation and tight control of government spending and borrowing is required to allow the private sector of the economy to flourish. The key is to help provide the right incentives for individuals and businesses. (Pettinger)

Despite all of the benefits of using fiscal policy, there is some criticism of it. Increasing taxes to reduce AD may cause disincentives to work, if this occurs there will be a fall in productivity as AS would fall. However higher taxes do not necessarily reduce incentives to work if the Income Effect dominates. Reduced government spending to decrease AD could adversely affect public services such as public transport and education, causing market failures and social inefficiency. (Pettinger) It is also not easy to tell if real GDP is above or below potential GDP. Fiscal stimulation might occur too close to full employment, in which case it will increase the price level and have no long term effect on real GDP. The legislative process is slow, and it is difficult to take fiscal policy actions quickly. The economy may benefit from fiscal stimulation now, but it will take Parliament many months to act. By the time the action is taken the economy may need an entirely different fiscal policy action. (Parkin, Powell and Matthews)
An expansionary fiscal policy will also cause an increase in the budget deficit, which has many adverse effects. A higher budget deficit will require higher taxes in the future and may cause crowding out. Crowding out is when increased government spending results in decreasing the size of the private sector. If the government increases spending it will have to increase taxes or sell bonds or borrow money, both methods reduce private consumption or investment. If this occurs AD will not increase or will increase only very slowly. (Pettinger) When governments fund a deficit, interest rates can increase because government borrowing created a higher demand for credit in the financial markets. This causes a lower aggregate demand for goods and services, contrary to the objective of a fiscal stimulus. Neoclassical economists generally emphasise crowding out while Keynesians argue that fiscal policy can still be effective especially in a liquidity trap where crowding out is minimal. Monetarists however point to the experience of Japan in the 1990’s where a liquidity trap was not solved by government borrowing. (Pettinger) They believe that the use of fiscal policy will only have a temporary effect on aggregate demand and employment, and that monetary policy is a more effective instrument for controlling demand and inflationary pressure. (Riley 2006) Higher interest rates from government borrowing also attract foreign capital from foreign investors. This is because, all other things being equal, the bonds issued by a country carrying out expansionary fiscal policy now offer a higher rate of return. When foreign capital flows into the country undergoing fiscal expansion, demand for that country’s currency increases. The increased demand causes that country’s currency to appreciate. Goods originating from that country now cost more to foreigners than they did before, consequently exports decrease and imports increase. (Parkin, Powell and Matthews 2008)

In the 1950, 60s and 70s the government was keen to use fiscal policy to stabilize the economy. It was thought that the government could ensure full employment by increasing AD when necessary. During this period it appeared that there was a trade off between unemployment and inflation as suggested by the Phillips curve. In the 1970s however the economy experienced stagflation. This involves an increase in unemployment and inflation at the same time. (Pettinger) Current UK demand policy tends to concentrate on the use of monetary policy, as it is easier to change the interest rate than levels of tax and spending. In 2009, due to the financial crisis, the government also turned to fiscal policy to try to stimulate economic activity. When Gordon Brown was Chancellor, the Labour party officially adopted the ‘Golden Rule’ of fiscal policy. The Golden Rule states that over the full economic cycle the government should only borrow to invest for future needs, current needs should be met by tax revenues. In conjunction with the Golden Rule the UK government also seeks to follow the Sustainable Investment Rule, which would keep national debt at 40% of GDP. By the end of 2008 estimated public debt had already risen to 42%. The justification is that a severe recession needs Keynesian stimulus to revive it. (Caploe)

References

Caploe D. Fiscal Policy. Available from: http://www.economywatch.com/world_economy/united-kingdom/bank-of-england-monetary-fiscal-policy.html (accessed 25.3.11)

Easterly W (1993) Fiscal policy and economic growth. Journal of Monetary Economics 32. 417-458

Parkin, Powell and Matthews (2008) Economics. Essex: Pearson education Limited

Pettinger T. Fiscal Policy. Available from: http://www.economicshelp.org/macroeconomics/fiscal-policy/fiscal_policy.html (accessed 25.3.11)

Riley G (2006) Fiscal Policy. Available from: http://tutor2u.net/economics/revision-notes/as-macro-fiscal-policy.html (accessed 25. 3.11)

Similar Documents

Free Essay

Fiscal Policy

...Assignment On Fiscal Policy Issues: ← What is the most prominent document that elaborates the Fiscal Policy of Bangladesh? ← As head of the government how would you design your next fiscal policy? Submitted By Md. Mizanur Rahman Roll No: 03 MPA in GPP April 18, 2011 Introduction Fiscal policies play a main role to the economic development of a country. It is the decision of the government about How to earn revenue and gather resources from various sources, for what to spend those earnings and resources, how much to spend and, when to spend. Main elements of fiscal policy are a) Government income and b) Government expenditure The most prominent document that elaborates the Fiscal Policy of Bangladesh is the National Budget passed in the Jatio Sangsad (The National Assembly of Bangladesh) every year. Fiscal Management in Bangladesh Fiscal management one of the big challenges for any government and it is more crucial for a developing country like Bangladesh. So the policy makers need to design fiscal policy very carefully. Maintaining macroeconomic stability and attaining economic growth are the main tasks. So we need to go through the following process to designing and managing fiscal policy: ➢ Inflow of money management for government income ❖ To maintain its daily activities, i.e. to run the government ❖ To ensure protection for the helpless ❖ To provide necessary services to...

Words: 462 - Pages: 2

Free Essay

Fiscal Policy

...Wells 2009) a brief explanation of fiscal policy is when the government uses taxes, government transfers and government purchases of goods and services to shift aggregate demand curve to the right to help heal the economy. (Reem Heakal 2010) describes it in simpler terms as the means by which the government adjusts its levels of spending in order to monitor and influence a nation’s economy. It is the sister strategy to monetary policy with which a central bank influences a nation’s money supply. Reem Heakal 2010 explains that Keynesian economics in theory can influence the macro economy by influencing productivity levels by increasing or decreasing taxes and public spending. This fiscal policy is set in place to get the economy back on track by increasing consumer spending and lowering unemployment. There are tools in the fiscal policy. Ex.: Is an investment tax credit which is a tax break to consumers. (Finishing the Job 2010) talks about the economic crisis was aided with swift stimulus packages to 130 million Americans and continued to find creative ways to unfreeze the credit markets. To summarize fiscal policy is too used to: Stimulate the economy, return to full employment, stabilize prices and combat inflation. Expansionary and contractionary means what it sounds like. We want to expand the economy and aggregate demand (A shift to the right in the demand curve) with government spending thus balancing it with contractionary policy ( A shift to the left in the......

Words: 1195 - Pages: 5

Free Essay

Fiscal Policies

...Fiscal policies are utilized to influence the economy via the government revenue and taxes; two types are discussed in Chapter 31, expansionary and contractionary. Expansionary fiscal policies are utilized during a recession to lower taxes, increase the aggregate demand, government spending, and real GDP. The overall goal is to determine the direction of the country; expansionary fiscal policies create budget deficit when it is balanced at the outset. The expansionary policy will close a recession gap, increase spending and create an aggregate demand curve because the people have money for spending on products and services; thereby, increasing the economic condition of the country. For example, when the unemployment rate is high, the government, specifically the Federal Reserve & the U.S. Treasury will boost the economy by increasing the amount of money supplied to the U.S. and reduce the discount rate, and reserve. On the other hand, the contractionary fiscal policies control demand-pull inflation and restrict government spending by increasing taxes. The overall goal of a contractionary fiscal policy is to lower aggregate demand and inflation; creating a budget surplus. In other words, it does the opposite of an expansionary fiscal policy to sustain the economic condition by decreasing the aggregate demand curve for products and services. Unfortunately, it slows the growth of the economy because the people have less income for spending (McConnell, Brue, & Flynn,......

Words: 256 - Pages: 2

Premium Essay

Effectiveness of Fiscal Policy

...Keynesians and Monetarists over the Effectiveness of Fiscal and Monetary Policy in the Is-Lm Framework In: Business and Management Keynesians and Monetarists over the Effectiveness of Fiscal and Monetary Policy in the Is-Lm Framework Discuss the difference between Keynesians and monetarists over the effectiveness of fiscal and monetary policy in the IS-LM framework. Introduction In economics there are two main schools of thought; these schools differ in their belief of what policies are best suited to attain full employment in the economy. Keynesians tend to favour demand side policies and are more prone to intervene in the market and therefore prefer to use fiscal policy whilst monetarists believe adjustments in money supply is more appropriate in stabilising the market ,therefore preferring monetary policy.   In this essay I will discuss the views of Keynesians and monetarists regarding the effectiveness of monetary and fiscal policies in controlling aggregate demand through the IS-LM framework.   I will first provide a brief description of the curves explaining their formation and what they represent and then I will go on to examine monetary and fiscal policy within the   IS-LM framework. Finally, I will examine the views of monetarist and Keynesians regarding the effectiveness of both policies in raising the level of national l income and also consider the extreme cases. IS-LM framework The IS-LM model was initially developed by John Hicks in 1937 but was made......

Words: 360 - Pages: 2

Free Essay

European Fiscal Policy

...European Fiscal Policy: Coordination of fiscal policy in Eurozone Wibowo Suhaidi (1235036) Tilburg University Course: Financial Economics Professor: S.C.W. Eijffinger October 2011 ABSTRACT The Stability and Growth pack has been discussed extensively in determining whether it is sufficient to undermine fiscal policy coordination in the Eurozone. Even before the recent sovereign debt crisis hitting the Eurozone the SGP has been in much of critics and the current situation calls for deeper analysis on the SGP and whether more coordinated fiscal policy in Eurozone is necessary in strengthening fiscal policy framework. This paper analyzes the implementation of fiscal policy in Eurozone with the SGP as the guideline and found out that despite effectively maintain the budgetary balances of Eurozone countries, the SGP failed to deliver overall fiscal stability. Therefore, a more coordinated form of fiscal policy is required in order to achieve the goal of fiscal stability in Eurozone.   1     I. Introduction The formation of European Monetary Union and the adoption of Euro as the single currency have the consequence that member countries are losing their monetary policy independence at the national scope. Therefore, one possible solution is to use fiscal policy in order to mitigate the asymmetric shocks, as fiscal policy is still on the hand of the national government of each member countries. However, from the Monetary Union point of view it is not desirable......

Words: 1754 - Pages: 8

Free Essay

Fiscal Policy

...Fiscal Policy ECON372 Fiscal Policy Fiscal policy is the government’s way of stimulating or slowing down the economy. Actions taken by the government can slow growth if things are moving too fast or stimulate growth if the economy is in a lull. Walmart, a major retailer in the United States, is one of the many organizations that are influenced by fiscal policies. Tax rates and spending can affect the organization’s ability to sell goods and services as well as create jobs for the economy. Based on fiscal policies implemented and economic predictions, there are a few recommendations that can be made to Walmart in order to positively influence the economy and their business. Federal Government Spending Fiscal policy is changes in government spending and taxes in order to influence the economy in some way. It works by changing the level or composition of aggregate demand (AD). Government spending in the United States has steadily increased from 7% of GDP in 1902 to almost 40% today (Chantrill, 2015). A decent amount of federal spending has gone for health care, education, pensions, and welfare programs. Defense spending in the United States has fluctuated in the last century, rising from 1% of GDP, peaking at 41% in World War II, declining from 10 percent in the Cold War to five percent today (Chantrill, 2015). Government spending on education has expanded from about one percent of GDP in 1900 to peak at 6 percent in the second decade of the 21st century.......

Words: 1678 - Pages: 7

Premium Essay

Fiscal Policy

...Fiscal Policy Paper Juan Mendez ECO/372 November 10, 2013 Adelaida-Torres-Dilan Fiscal Policy Paper This paper will detail how and why the U.S. deficit, surplus and debt have an impact on the U.S. Economy. The effect of deficits, surplus, and debt can impact unemployment and University of Phoenix in many different ways. A budget deficit occurs when the government spending exceeds the revenue in a given time period. A budget surplus occurs when the government spending is less than the revenue in a given time period. The national debt is a running total of all deficits minus all surpluses. The United States borrows money by having the Department of treasury issue treasury bonds and then the bonds are purchased by U.S. companies, individuals, and foreign governments, companies, and individuals. The size of the federal deficit/surplus is very sensitive to the business cycle in the United States. Larger deficits during recessions and smaller deficits during expansions are part of the normal up and down movement of the United States Debt. Automatic stabilizers of the economy are included as part of the annual budget and include payments such as unemployment benefits, food stamps, and other welfare benefits. These automatic stabilizers usually increase during a recession and decrease during an expansion. Income tax revenue is also considered an automatic stabilizer because tax revenue usually decreases during a recession and increases during an expansionary......

Words: 373 - Pages: 2

Free Essay

Fiscal Policy

...Y V Reddy: Fiscal policy and economic reforms Address by Dr Y V Reddy, Governor of the Reserve Bank of India, at the National Institute of Public Finance and Policy (NIPFP), New Delhi, 26 May 2008 (edited transcript). * * * Respected Professor Govinda Rao and distinguished scholars, I am honoured by my friend, Prof. Govinda Rao’s, kind invitation to me to visit the National Institute of Public Finance and Policy (NIPFP). I had the opportunity of working very closely with the NIPFP on several occasions. Apart from my personal affinity to the NIPFP, there is a close relationship between the Reserve Bank of India (RBI) and the NIPFP, from an institutional point of view also. For instance, Prof. Govinda Rao is a Member of the Southern Local Board of RBI. Initially, I thought of speaking on fiscal policy and economic reforms from a central banker’s perspective. I realised later that while I have been working as a central banker over the last one decade, I had worked for most parts of the three decades prior to that in the Ministry of Finance, in the Government of India as well as in the Government of Andhra Pradesh. So it was a difficult choice for me as to whether I should give a fiscal view of the monetary policy or a monetary view of the fiscal policy. I have worked for a short period in the World Bank, which gives a global governments’ view and also in the IMF, which gives a global monetary authority’s view. As a via-media, I have opted to give a practitioner’s perspective...

Words: 7145 - Pages: 29

Premium Essay

Fiscal Policy

...Topic 4 – Fiscal Policy Refers to the governments choices regarding the overall level of government purchases or taxes * Government spending – on health sector, education, infrastructure, defence. * Taxation policy – income tax, sales tax (VAT), corporate tax, capital gains tax. Fiscal policy and aggregate demand * Government spending – increase in G spending → AD shifting right * e.g. Gov places £10 billion order for new school buildings → building contractor has increased demand for output → hires more staff and increases production. * Taxation – * Income tax cut → consumption increases → AD shifting right * Corporate tax cut → investment increases → AD shifting right * If tax cuts are seen as temp then AD shift may be smaller Multiplier Effect The additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending. * Example continued… * Positive impact - The Gov buys £10 billion of buildings from Bob and Co, → demand from gov raises employment and profits at Bob and Co → as workers see higher earnings and firm owners see higher profits → increase own spending on consumer goods and so on… This is the multiplier effect. * Negative impact could be that spending on foreign goods may increase → neg impact on AD as imports increase. * Size of multiplier depends on marginal propensity to consume and import. * SHOW IMPACT OF......

Words: 894 - Pages: 4

Premium Essay

Fiscal Policy

...Measuring Economic Health and Fiscal Policy Paper The GDP is used to measure the business cycle of an economy. GDP is the value of all services and goods made within a country in a specified time period. GDP includes all and public and private spending, government use, investments, and exports minus imports within a country. GDP is for measuring the economy of one country. The GDP is the key factor in any business cycle. The business cycle is figured out by the goods and services and the number of people employed. The business cycle is like an aggregate economic indicator and the GDP is the best one. The business cycle changes and has five stages: growth, peak, recession, trough, and recovery, and the GDP affect the business cycle because its factors affect the business cycle. When the GDP rises in the economy there is a growth in the business cycle, and when there is a fall in the GDP then there is a recession in the business cycle. (Hubbard & O’Brien, 2010) The government has a major part in shaping our national fiscal policies.   The President and Congress make fiscal policies to help our economy. The Federal Open Market Committee monitors the economy. The Internal Revenue Service is a department that is in charge of making sure that everyone pays their share of taxes. The Federal Trade Commission department monitors all deals that have acquisition mergers, credit and loans, and regulate debt collection, example Enron. The Department of Treasury manages......

Words: 499 - Pages: 2

Premium Essay

Fiscal Policy

...Fiscal Policy 1. Meaning of Fiscal policy Fiscal policy refers to the way government utilizes taxation and spending with the aim of influencing the overall economy. Usually, the government use fiscal policy to ensure strong and sustainable economic growth and reduce poverty (Horton & El-Ganainy, 2009). The function and objectives of fiscal policy have increasingly gained popularity in the current financial crisis as most governments have stepped in to promote financial systems, jump-start growth, and solve the implications of the crisis on vulnerable groups. The main goals of fiscal policy include * Maintain low rate of inflation * Stimulate economic growth especially during economic recession * Typically, fiscal policy works to stabilize economic growth, bust economic cycle and avoid a boom 1. Responsibility for fiscal policy The executive (the president) and the Congress are responsible for fiscal policy 2. Difference between fiscal policy and monetary policy Fiscal policy is concerned with changes in taxation and changes in federal government purchases while monetary tool is involve shifts in supply of money and in the interest rates. Both the monetary and fiscal instruments are aimed to achieve favorable macroeconomic policy goals. When policymakers aim to affect the economy, they manipulate the fiscal policy and the monetary policy. The central of bank any country indirectly influences activity by changing the quantity of money under......

Words: 548 - Pages: 3

Free Essay

Fiscal Policy

...1. What is fiscal policy? Fiscal policy is the use of government spending and consumption to influence the economy. We can also summaries fiscal policy as government policy that affects the macroeconomic condition. Government usually uses fiscal policy to improve unemployment rate, control inflation and to promote strong growth in the economy. 2. How can it be used to get the economy out of recession? First, the government may lower the tax rates to increase the economic growth. If less money is paid on taxes people have more money to spend or invest which will help to improve the economic growth. Secondly, increasing government spending also will help. Additional government spending will create more job opportunities, which will lower the unemployment rate. 3. How can it be used to get the economy out of the situation where the economy is in an expansionary period where we exceed long run potential. Expansionary fiscal policy will lead to an increase in government budget deficit. In this case government should decrease its spending and increase taxes. Lower government spending will decrease the aggregate demand. Increasing taxes and reducing government spending will decrease government’s budget deficit. 4. Do both situation results on different impact on inflation? Why or Why not? Yes, both situations result on different impact on inflation. Expansionary fiscal policy lead to inflation because of the higher demand of the economy, which is caused by......

Words: 308 - Pages: 2

Premium Essay

Fiscal Policy

...Reserve's recent policy decisions and place these actions in an international context. what happens when there is a surplus of imports brought into the U.S.? what is a specific product with an import surplus, and the impact that has on the U.S. businesses and consumer involded. The U.S. economy has faced significant headwinds, and, although the economy has been expanding since mid-2009, the pace of our recovery has been frustratingly slow. The headwinds include the effects deleveraging by households, the still-weak U.S. housing market, tight credit conditions in some sectors, spillovers from the situation in Europe, fiscal contraction at all levels of government, and concerns about the medium-term U.S. fiscal outlook. In this environment, households and businesses have been quite cautious in increasing spending. Accordingly, the pace of economic growth has been insufficient to support significant improvement in the job market; indeed, the unemployment rate, at 7.8 percent, is well above what we judge to be its long-run normal level. With large and persistent margins of resource slack, U.S. inflation has generally been subdued despite periodic fluctuations in commodity prices. Consumer price inflation is running somewhat below the Federal Reserve's 2 percent longer-run objective, and survey- and market-based measures of longer-term inflation expectations have remained well anchored. The global economic outlook also presents many challenges, as you know. Fiscal and......

Words: 440 - Pages: 2

Premium Essay

Fiscal and Monetary Policy

...important. Policy makers judge the economy by measuring these macroeconomic indicators. The performance of the economy is measured in terms of the achievement of its economic objectives. Policy makers develop fiscal and monetary policy to achieve these long term objectives of the economy. Fiscal Policy Fiscal policy is used to collect revenue for the government in terms of taxes. Main tools of fiscal policy are taxes and government spending. If government make any changes in tax structure and government spending it effect the aggregate demand and level of economic activity in the country. To stabilize the economy on a business cycle fiscal can be used. Fiscal policy is made under the law of a legislature. Making any changes in the fiscal policy tools it effects the level of activity and aggregate demand in the country, it also effect the savings and investment in the economy, and distribution of income. * Expansionary fiscal policy In expansionary fiscal policy government increases spending and decrease taxes. To correct the problem in business cycle transfer payments are increased. Expansionary fiscal policy is used to close the recessionary gap, to decrease unemployment and improve the economic condition during recession. * Restrictive fiscal policy In restrictive fiscal policy government increases taxes and decrease its spending and transfer payments to resolve the problem of inflationary gape in the business-cycle expansion. The goal of restrictive policy......

Words: 2178 - Pages: 9

Premium Essay

Fiscal and Monetary Policy

...Fiscal and Monetary Policy The textbook states clearly that the aggregate supply curve (and the economy in general) is heavily influenced by unemployment: “The Keynesian range of the curve is horizontal because neither the price level nor production costs will increase or decrease when there is substantial unemployment in the economy.” (Tucker) This shows that high unemployment should be prevented as much as possible, and quickly alleviated if it begins to rise. “Our Fiscal Policy Paradox”, written by Alan S. Blinder, explores the current fiscal and monetary policy options, and describes which options should be implemented in order to pull the economy out of the recession. The fiscal options that are given are: 1. New jobs tax credit 2. Government hiring 3. Cut sales taxes The tax credit for new jobs would simply be an incentive for employers to hire more people in order to decrease unemployment, which will increase spending in general, a key factor in pulling the nation out of its economic trough. This strategy has been pursued, but not effectively. The author explains: The government could offer tax breaks to firms that increase their employment above some base level. In fact, Congress did just that with the HIRE (Hiring Incentives to Restore Employment) Act in March. But it was legislated on a pitifully small scale and will expire at year's end. We need a larger version that stays around for a while. (WSJ.com) Providing such a credit would......

Words: 826 - Pages: 4