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| Fiscal Policy |
Fiscal policy is the process through which a government modifies its expenditure and tax rates in order to track and impact the economy of a country. A central bank influences a country's money supply through this method, which is similar to monetary policy. These two strategies are used in a variety of ways to guide a country's economic objectives. Here's how fiscal policy works, how it needs to be managed, and how it might influence different people in an economy.
Consider the following scenario: two economies. Country A has been experiencing an economic boom for some time. However, as a result of this, Country A is experiencing excessive inflation.
Country B, on the other hand, has been in a slump for a long time, with significant unemployment generating widespread hardship. However, neither country's self-correction process is working. Is there anything you can do about it?
Yes! Both administrations can utilise fiscal policy to restore "normalcy" to their respective countries. Fiscal policy (changes in government spending or taxation, for example) can have an impact on output, unemployment, and inflation.
To get out of its slump, Country B needs to improve its productivity. Their government can boost output by implementing expansionary fiscal policies. Expanding government spending, lowering taxes, or increasing government transfers are all examples of expansionary fiscal policy instruments. Any of these actions will boost aggregate demand, resulting in increased output, employment, and price levels.
Country Inflation is generated by producing more than can be sustained, hence lowering output would solve the issue. Instead, they can use fiscal policy measures that are more contractionary, such as raising taxes or reducing government spending or transfers.
Any of these actions will reduce aggregate demand in Country A, resulting in lower output, employment, and price levels. Governments often engage in expansionary fiscal policy during recessions and contractionary fiscal policy when inflation is a concern.
To accomplish macroeconomic goals, fiscal policy is used.
Consider a government that wants to end a recession or slow a growth. Its specific objectives would be to return the economy to full employment or to keep inflation under control, as the case may be. Fiscal policy can assist them in achieving their objectives.
Government expenditure and taxes (or transfers, which are akin to "negative taxes") are the tools of fiscal policy. Expansionary fiscal policy is used to close negative production gaps in an economy that is generating too little (recessions). Increasing government spending or lowering taxes are both examples of expansionary fiscal policy.
It is necessary to contract an economy that is creating too much. In this circumstance, a contractionary fiscal policy (decreased government expenditure or higher taxes) is the best option.
For example, if Country B is in the midst of a recession, the government may issue a tax rebate to everyone (an example of expansionary fiscal policy). Here's how it'll go down: The rise in discretionary income is due to the tax refund. Increased disposable income leads to increased spending, and increased consumption leads to increased aggregate demand. A rise in aggregate demand leads to a rise in output and a reduction in unemployment. Inflation will rise as a result of the drop in unemployment and increase in output.
Country A is undergoing a period of growth and inflation. They slashed the government's budget. Here's how it'll go down in Country A: First, because government spending is a component of AD, a reduction in government spending results in a reduction in aggregate. Because a fall in AD leads to a new short-run equilibrium with lower output, increased unemployment, and lower price levels, a decrease in AD leads to a decrease in output.
Government expenditure has a direct impact on AD, whereas taxes have an indirect impact.
What are the differences between the effects of government expenditure and taxes? Because government expenditure is a component of AD, when a government participates in fiscal policy through government spending, the effect is immediate. For example, if the government pays $1000 to a farmer in Country B for 500 pounds of rice, that $1000 is counted in the G component of AD and real GDP, and then the expenditure multiplier kicks in.
When a government uses taxes or transfers to implement fiscal policy, however, the impact is indirect. If the government of Country B sends that farmer a $1000 tax rebate instead of directly purchasing anything from him, the effects of that move will not be felt until the farmer actually spends that money. In fact, if he stuffed the entire refund under his mattress, it would have no effect!
However, if the farmer saves $200 and spends the rest on shopping, the total expenditure is $800. The multiplier effect is then triggered by the purchases.
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