Fiscal policy is the government’s attempt to influence the economy by setting and changing taxes, government spending, and the government’s deficit and debt (Matthews et al 2003). Contractionary fiscal policy is, therefore, a policy where a decrease in government’s spending, an increase in taxes plus a decrease in transfer payments are applied to mitigate the inflationary issues that occur during a business cycle expansion. Thus, it restrains the economy, decreases the inflation rate and closes the inflation gap. This Essay will investigate the extent of the contribution of this policy to a decline in economic activity. Consequently, it will analyse the effects on economic activity under the Keynesian theory, the “classical” theory, and the Mundell-Fleming model. Furthermore, commentary on the results of an empirical study under a fixed exchange rate regime of the Obstfeld and Rogoff model will be provided and contrasted to other theories and models.
Contractionary fiscal policy, which is a reduction in the budget deficit, works through government spending and taxes. However, it is easier to separate them into three tools, namely, government purchases, taxes and transfer payments to see their effect on economic activity in the short run, medium run and long run. Government purchases are government expenditures, which are undertaken by government agencies, on final goods and services or gross domestic product in an economy. These include small items such as paper clips, office furniture, and teachers’ salaries to motorway construction. Hence, contractionary fiscal policy will involve a cut in funds appropriated to the various agents, thereby reducing aggregate production, income and inflation rates. Consequently, this policy is ...
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Works Cited
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In Keynesianism, government uses fiscal policy, which is a list of policies that government spending and taxing can be used to improve the performance of an economy. The government produces stabilization by taxing and spending yearly plans. Taxing can occur when inflation is high, and lowering taxes tends to occur during a high percentage of unemployment. By lowering taxes, it increases disposable income or the amount of income that goes to financial responsibilities. When people have more money, they are able to spend more, which in return goes into jump starting the economy.
This paper is structured as follows. In order to better understand the Great Recession, the first section includes an examination on some of the key causes. Section two outlines some of the fiscal policy responses made by the government to the Great Recession. In the third section, relevant extant literature relative to studies on the fiscal policy implemented in response to the Great Recession will be discussed with a focus on potential problems. For problems noted, recommendations for resolution will be included. The objective of this paper is to consider relevant problems that might require further consideration in a research project about the long-term after effects of fiscal policy implemented by the U.S. government in response to the Great Recession.
Stratmann, Thomas, and Gabriel Okolski. "Does Government Spending Affect Economic Growth? | Mercatus." Mercatus. 10 June 10. Web. 20 Nov. 2011. .
The Classical economists believe that these are “temporary” changes that will correct themselves in the long run. They feel that an economy will always tend towards operating at its potential output (as given by the long-run aggregate supply curve. Nothing needs to be done by the government because normal market forces will serve to self-correct these issues. On the other hand, Keynesian economics argue that the gap between the lower and the potential levels of output is due to a change in aggregate demand. They argue that this gap can exist for a long time and that the gap can be pushed to close faster if the government enacts fiscal and monetary policies. There are differences in how each policy works to close the recessionary gap caused by a drop in aggregate
In the study of macroeconomics there are several sub factors that affect the economy either favorably or adversely. One dynamic of macroeconomics is monetary policy. Monetary policy consists of deliberate changes in the money supply to influence interest rates and thus the level of spending in the economy. “The goal of a monetary policy is to achieve and maintain price level stability, full employment and economic growth.” (McConnell & Brue, 2004).
The reduction of government role in the economy will affect fiscal policy by decreasing deficit spending a...
Walker, Bruce. "Euro Likely to Keep Losing Value." The New American. The New American Magazine, 7 July 2010. Web. 23 May 2011. .
Everyone has their own political leaning and that leaning comes from one’s opinion about the Government. Peoples’ opinions are formed by what the parties say they will and will not do, the amounts they want spend and what they want to save. In macroeconomic terms, what the government spends is known as fiscal policy. Fiscal policy is the use of taxation and government spending for the purposes of stimulating or slowing down growth in an economy. Fiscal policy can be used for expansionary reasons, which is aimed at growing the economy and increasing employment, or contractionary which is intended to slow the growth of an economy. Expansionary fiscal policy features increased government spending and decreases in the tax rates as where contractionary policy focuses on lowering government spending and increasing tax rates. It must be understood that fiscal policy is meant to help the economy, although some negative results may arise.
During the time of economic crisis starting around 2010 different rationalities have been taken to try and continue economic growth while maintaining a stable government system that is helping and not hurting. When examining government spending and how it affects the growth of the Gross Domestic Product (GDP) there seems to be disagreements on if it was helping or damaging the prospective growth that could be made. By using the Multiplier Effect the government can estimate how to adjust their government spending and how it effects the spending of the consumer, investments and spending of country’s exports.
After analyzing the data and the theory, we have provided our conclusion weather tax cut is better for the stimulation of growth or Government spending is? This report explains the big macroeconomic debates of the present times. It seeks to explore the debate within fiscal policy itself between tax cuts and government spending. We have tried to explain the argument through some theories and through some data collected from Indian econ...
*“Delocation and European Integration—is structural spending justified?” by Karen Midelfart-Knarvik and Henry Overman, in Economic Policy, October 2002.
Fiscal Policy involves the Government changing the levels of Taxation and Government Spending in order to influence AD (Aggregate Demand) and therefore the level of economic activity.
According to Maynard, John (1930), various measured may be taken by government in order to improve the state of the economy and probably move the economy from a recession or even speed this process. Various players can play a role in improving the economic though as Keynesian theory explains the government plays a great role in this compared to other players like the private sector. The government can therefore use various measures through its budgeting policies, fiscal policies and monetary policies by the Central Bank. It’s on this basis that the UK coalition government has proposed slashing of its budget to reduce the overall spending in the economy.
The Social Studies Help Center (n.d.). Monetary and Fiscal Policy. Retrieved November 5, 2011, from http://www.socialstudieshelp.com/eco_mon_and_fiscal.htm
These two policies use to try to shorten recessions. Fiscal policy has its initial impact in the goods markets, then monetary policy has its initial impact mainly in the assets markets, which both effect on both level of output and interest rates. (R. Dornbusch et al., 2008)