Fiscal Policy And Its Effects On Economic Growth - 1260 Words

Fiscal policy is a tool that is used by the government to correct fluctuations in the economy. Fiscal policy involves the government manipulating the level of government expenditure and/or rates of taxes to affect the level of aggregate demand (Sloman and Sutcliffe, 2001, p.633). The business cycle is inter-linked with this policy as it illustrates the short-term increase and decrease in the economy, noted as periods of recession and expansion. The idea of fiscal policy is simple when the economy is sluggish or too hasty the government will intervene by changing government spending on taxes. When the economy falls into a deep recessionary gap, the government can increase government spending and reduce taxes. This will increase the†¦show more content†¦Two instruments which fiscal policy can be modulated are taxes (imposed by the government) and government expenditure (also known as public expenditure). Decisions about fiscal policy are in the hands of the ministry of finance i.e. the United Kingdom – HM Treasury. Taxes can be altered by the policymakers resulting in a shift again with the AD curve like unemployment benefits. Government expenditure (G) are public expenses on goods and services, for instance, spending on education; improving labour productivity and, therefore, shifting the AD curve. The government can use expansionary or deflationary fiscal policy to get the anticipated results. Firstly, in order to understand how expansionary fiscal policy would be used, we need to understand the ‘deflationary gap’. The deflationary gap is the difference between the full level of employment and the actual level of the economy. Consequently, the government can use expansionary fiscal policy to eliminate the gap. For instance, government spending creates jobs and income for labourers, in turn, these labourers spend more of their addition income and so forth increasing consumer spending and the entire economy. A tax reduction will incre ase disposable income. On the other hand, a deflationary (contractionary) fiscal policy is vividly understood when the economy has an ‘inflationary gap’. An inflationary gap is when the aggregate demand exceeds the productive