Answer to Question #129503 in Macroeconomics for alice

Question

explain what is meant by fiscal policy

Answer 1

Fiscal policy is a macroeconomic policy used by central authorities (the government) as an economic tool to achieve the macro economic objectives through use of government spending (G) and taxation (T) to influence aggregate demand (AD) and the level of economic activity (GDP).

Fiscal policy is used as an instrument to:

• Stabilise the level of economic growth in the economy by avoiding rapid fluctuations in the business cycle (boom and burst economic cycles)
• Control inflationary pressure, especially demand pull inflation, by changing the patten of spending on goods and services in the economy by both the government and households.
• Redistribute national income to achieve equality by establishing tax brackets so that the amount of income or corporate tax payable corresponds to the amount of income earned.

Fiscal policy is viewed from two angles namely, the expansionary and the deflationary fiscal policy.

Expansionary fiscal policy - it is also known as loose fiscal policy, and is used to increase aggregate demand in order to stimulate economic growth in recessionary periods. This is achieved through increase in government spending in the domestic economy (G) and a reduction in taxation (T). A reduction in taxation, both direct and indirect, increases consumer disposable income and hence positively impacting AD. This promotes high economic growth and a reduction in unemployment level through investment stimulation.

Deflationary fiscal policy - it is also known as tight fiscal policy, and is used to keep inflation low, and reducing inflationary pressure in the macroeconomy. This is achieved through reduction in government spending in the domestic economy (G), and an increase in both direct and indirect taxes (T). An increase in taxation constricts aggregate demand by reducing consumer disposable income; controls excess liquidity, and hence demand pull inflation.

References:

https://www.tutor2u.net/business/reference/fiscal-monetary-policy

https://www.economicshelp.org/macroeconomics/fiscal-policy/fiscal_policy/