Top-Rated Free Essay
Preview

Fiscal Policy effectiveness

Satisfactory Essays
420 Words
Grammar
Grammar
Plagiarism
Plagiarism
Writing
Writing
Score
Score
Fiscal Policy effectiveness
When an economy has just come out of a recession a persistent budget deficit exists to in order to stimulate the economy. However, the existence of this large deficit in the long run can evolve into a problem due to the financing of the debt, and the large opportunity cost it holds. For these reasons a government would want to reduce this. Blanchard & Johnson (2013) outline the two dominant fiscal tools that accomplish a reduction in the government deficit in the short run: increasing taxes and decreasing government spending. Such manipulation of fiscal policy is called fiscal consolidation. In conjunction with this question, the behavioral equations dictate that the endogenous variables in this closed economy are consumption, disposable income and investment. This essay will analyse and evaluate the effects of each fiscal tool on all endogenous macroeconomic variables, then justify which fiscal tool is the most beneficial to use. This will be done by analyzing the effects the fiscal tools have on this question’s equilibrium of the goods and financial markets (Fig. 1). See Appendix A for the steps of derivations for the IS/LM relations.

An increase in taxes has direct and indirect effects to the economy. Consumers and firms are directly taxed more through income and corporation tax. For the consumer, this decreases their disposable income that leads to a decrease in consumer demand. For the firms, they experience a decrease in profits consequently leading to a decrease in investment. When indirect taxes increase, higher prices and lower real income is present. Overall this leads to a decreased aggregate demand through the economic intuition; higher taxes cause decreased disposable income that causes consumption to decrease in the economy, consequently decreasing demand then output. Upon looking at the intricate components of the endogenous variables we can see why they decrease, thus decreasing aggregate demand. Disposable income decreases, as the amount of income they have after paying their taxes is less. An increase in tax would have an effect on consumer’s confidence as they are less optimistic about the future and consequently decrease their propensity to consume () as the proportion of the disposable income that individuals desire to spend on consumption, decreases due to a decreased disposable income (). In this climate consumer’s propensity to save for the future is the more dominant factor. In terms of the business sector, firms have a smaller amount of income for investment. As a consequence of all these variables decreasing, output decreases from;

to

The increase in taxes can be shown by T

You May Also Find These Documents Helpful

  • Better Essays

    Fiscal Policy

    • 1560 Words
    • 7 Pages

    In the current economic recession, the United States’ fiscal policy has placed unrest and instability among the population. The positive and negative outcomes of the fiscal policy, with regard to the country’s deficit, surplus, and debt, have different effects on how many different people and organizations view the current economy, make decisions, and react to changes. The Unites States’ deficit, surplus, and debt affect not just the American tax payers but also future social security and Medicare users, unemployed individuals, students, exporters, and importers. The deficit, surplus, and debt also affect the gross domestic product (GDP) and also the United State’s financial reputation on an international level. Focus must be placed on making objective decisions that will provide both short-term and long-term benefits especially during economic uncertainty. Individual decisions during a recession has a great impact on the economy collectively; when people reinvest and increase spending in the tough economy, it can propel the economy towards the upward trend.…

    • 1560 Words
    • 7 Pages
    Better Essays
  • Good Essays

    Fiscal Policy Paper Eco372

    • 1420 Words
    • 6 Pages

    The United States deficit, surplus, and debt will always have an impact on taxpayers. In the state of high deficit the government seeks ways to cut and save money for debt payment. The government does this by pulling funding from programs that have little government impact. Increasing taxes also supplies the government with extra income. In addition to the reduction or elimination of certain tax credits, the government analyzes school funding for cost effectiveness. Each step the government takes has a trickling effect on taxpayer’s dollar.…

    • 1420 Words
    • 6 Pages
    Good Essays
  • Satisfactory Essays

    Between 2007 and 2009 the U.S. economy experienced a severe recession. In an effort to stimulate the economy, the federal government passed a stimulus package. Explain the federal government’s use of fiscal policy (the stimulus) to promote growth and employment. Support your ideas with concepts found in the assigned reading. Include the following in your response:…

    • 541 Words
    • 3 Pages
    Satisfactory Essays
  • Powerful Essays

    Fiscal policy is the use of presidential and governmental spending and taxation to change or even repair what is or might be wrong in the economy. The basic idea behind many of the fiscal policy ideas were introduced by British economist John Maynard Keynes during the Great Depression (Heakal, n.d.). When the government decides on the goods and services it will be purchasing, the payments it distributes, or even the taxes it collects, it is participating in fiscal policy. The economic influence of any change in the government budget can and in theory will benefit people such as a tax cut for families with children, can help raise their disposable income (Weil, n.d.).…

    • 1588 Words
    • 7 Pages
    Powerful Essays
  • Good Essays

    First, we look at expansionary fiscal policy. The Federal government has at its discretion a number of tools available. An increase in government spending(G) and a decrease in taxes, ceteris paribus, will shift the demand curve rightward pushing the economy out of recession. With a decrease in taxes, an increase in disposable income(Yd) occurs, which in turn increases both consumers marginal propensity to consume and marginal propensity to save. An increase of MPC means more money is being spent in the economy increasing the demand for goods and services. An increase in consumption(C), investment(I), government spending(G), and net exports(Nx) will raise the overall level of economic activity, increasing aggregate demand and shifting the aggregate demand curve to the right. By shifting the aggregate demand curve to the right, we increase real output bringing the economy out of recession into full employment and equilibrium.…

    • 639 Words
    • 3 Pages
    Good Essays
  • Good Essays

    Fiscal Policy

    • 483 Words
    • 2 Pages

    The traditional Keynesian approach to fiscal policy differs in three ways from that is presented in the Fiscal Policy Chapter in your textbook.…

    • 483 Words
    • 2 Pages
    Good Essays
  • Good Essays

    Fiscal Policy

    • 627 Words
    • 1 Page

    of economic activity. Fiscal Policies can be used in an effort to close a recessionary or an…

    • 627 Words
    • 1 Page
    Good Essays
  • Good Essays

    When the government decreases taxes, disposable income(Y-T) increases. That translates to higher demand (spending) and increased production (GDP). The fiscal policy also affects the supply side as income rate rates and structure of government payments can influence…

    • 341 Words
    • 2 Pages
    Good Essays
  • Satisfactory Essays

    eco/372 fiscal policy

    • 467 Words
    • 2 Pages

    Ho Ching’s power comes from Expert power because she is trained and very skillful in what she does, referent power because she is very relatable and has a lot of respect from her peers and coworkers and legitimate power because not only is she skillful but she is also trusted to be placed in a high position of power and fulfills her position well.…

    • 467 Words
    • 2 Pages
    Satisfactory Essays
  • Powerful Essays

    4. In an economic recession why is it that an increase in government spending is usually considered more effective than a reduction in taxes in providing fiscal stimulus to the economy? What does the balanced budget multiplier imply for the conduct of fiscal policy?…

    • 554 Words
    • 3 Pages
    Powerful Essays
  • Better Essays

    Fiscal Policy

    • 1391 Words
    • 6 Pages

    The people of the United States are by the fiscal policies. Team C will address the how and why the U. S. budget deficits, budget surpluses, and debt affect different individuals and institutions. There is a wide array of individuals affected by fiscal policy, which include tax payers, future Social Security and Medicaid users. The unemployed individuals and University of Phoenix students will be affected by fiscal policy. The U.S. financial reputation, an exporter, and importer, and affects of the GDP will also be covered about the affects of the U.S. fiscal policy.…

    • 1391 Words
    • 6 Pages
    Better Essays
  • Better Essays

    Fiscal Policy Paper

    • 1097 Words
    • 5 Pages

    The United States’ economy has gone through many different stages from deficits and surpluses to a large debt. These can affect people in many ways. This paper will cover the United States’ deficit, surplus, and debt and how it affects taxpayers, future Social Security and Medicare users, unemployed individuals, University of Phoenix students, the United States’ financial reputation on an international level, a domestic automotive manufacturing exporter, an Italian clothing company importer, and the Gross Domestic Product (GDP).…

    • 1097 Words
    • 5 Pages
    Better Essays
  • Good Essays

    A fiscal deficit is when a government's total expenditures exceed the tax revenues that it generates. A budget deficit can be cut by either reducing public expenditure or raising taxes. In this essay, I am going to analyse the benefits and costs of increasing tax rates to reduce fiscal deficits instead of cutting government expenditure.…

    • 883 Words
    • 3 Pages
    Good Essays
  • Good Essays

    The development of macroeconomic theory has shown policymakers how to reduce the severity of economic fluctuations. By “leaning against the wind” of economic change, monetary and fiscal policy can stabilize aggregate demand and, thereby, production and employment. Although monetary and fiscal policy can be used to stabilize the economy in theory, there are substantial obstacles to the use of such policies in practice. One problem is that monetary and fiscal policy does not affect the economy immediately but instead work with a long lag. Monetary policy affects aggregate demand by changing interest rates, which in turn affect spending, especially residential and business investment. But many households and firms set their spending plans in advance. As a result, it takes time for changes in interest rates to alter the aggregate demand for goods and services. Many studies indicate that changes in monetary policy have little effect on aggregate demand until about six months after the change is made. Fiscal policy works with a lag because of the long political process that governs changes in spending and taxes. To make any change in fiscal policy, a bill must go through congressional committees, pass both the House and the Senate, and be signed by the president. It can take years to propose, pass, and implement a major change in fiscal policy. Because of these long lags, policymakers who want to stabilize the economy need to look ahead to economic conditions that are likely to prevail when their actions will take effect.…

    • 501 Words
    • 3 Pages
    Good Essays
  • Satisfactory Essays

    Fiscal Policy Paper

    • 503 Words
    • 2 Pages

    Over the past week of class Team C has been discussing the effects the U.S.’s deficit, surplus and debt has had on the tax payers and future Medicare users of our great nation. While the United States is often considered one of the greatest countries in the world, why is it so difficult to get a grasp on our social security plan and our healthcare system?…

    • 503 Words
    • 2 Pages
    Satisfactory Essays