Topic 12: Fiscal policy is considered to be important tools and known as stabilizer for economy Study the role of fiscal in stabilizing economy in us Fiscal policy is considered to be a very important tools known as stabilizer for the economy It is used by government to mitigate adverse effects of growing too fast as well as negative economic growth I Literature review Definition of fiscal policies Fiscal policy is the setting of the level of government spending and taxation by government policymakers Meaning of stabilizer of the economy According to Keynesian economics, when the government changes the levels of taxation and governments spending, it influences aggregate demand and the level of economic activity Fiscal policy can be used to stabilize the economy over the course of the business cycle The two main instruments of fiscal policy are changes in the level, composition of taxation, and government spending in various sectors These changes can affect the following macroeconomic variables, amongst others, in an economy: - Aggregate demand and the level of economic activity; - Savings and Investment in the economy - The distribution of income There are there fiscal policies: expansionary fiscal policy, contractionary fiscal policy - In a depression: The real output is smaller than potential output and high inflation rate In this case, government should apply expansionary fiscal policy by increasing G and/or decrease T It leads to an increase in aggregate demand and output, a decrease in unemployment rate - In the economy with a high inlation rate, actual output exceeds potential output, government should apply contractionary fiscal policy by decreasing G and/or increase T It leads to a decrease in aggregate demand, otput and inflation rate but an increase in uneployment rate probably AD E2 AD1 AD2 E0 AD3 E1 Y Y2 Y1 Y0 For detail, when actual output (Y) is larger or smaller than potential output (Yp), the leaders must adjust to increase or decrease T, G and figure out the elements to effect the sustainable economic equilibrium We call it: ∆Y (∆Y= Yp –Y ) - If government spending is the only tool used in fiscal policy: So, government spending need to be adjusted: - If tax is the only tool used in fiscal policy: So, tax need to be adjusted : - If both G and T are used in fiscal policy: So, both G and T need to be adjusted: ( m: the multiple) - The investment regression analysis: when government spending increases or tax decreses, GNP (Gross National Product) will rise sharply, which leads to an increase in money demand Given money supply, a growth in interest makes a decline im imvestment As a result, GNP decreases because of a deep deficit which follows by an investment regression Therefore, the effficiency of fiscal poilicy decrease Important roles of fiscal policy - Fiscal policy aims to remain balanced budget: in this policy, government always reaches the balanced budget whatever levels of output are: In a recession Solution - Yun - BT) - G, T no changes - G, T - G no changes, T In a prosperous economy Solution - Y>Yp - ui0 (GYp - ui0 (G