Impact of Fiscal Policy on Total Demand and Economic Performance
Hackin' with Fiscal Policy: Stimulating and Slashing the Economy
Gettin' down to the nitty-gritty, fiscal policy steers the economy via tax and government spending tweaks. For instance, tax breaks unleash the beast known as aggregate demand, revvin' up economic activity.
Governments ain't like businesses and families, 'cause they got the power to decide on taxation and spending changes at will. For example, they might purposely slash taxes during a recession to supercharge aggregate demand and inject life into the economy.
Now, you might wonder why the economy depends on business and household sectors to recover. Truth is, they tend to be scrooge-like during a downturn. They hoard their dough, cut investments, and decrease consumer spending, with profits drop and job cuts looming. That's where Keynesian economists step in, preachin' the gospel of government intervention to kick-start the economy.
What's the Skinny on Fiscal Policy?
Fiscal policy is economic policy that wields budget changes to control the economy. It's armed with two weapons:
- Taxes
- Government spending
These weapons are used to achieve lofty macroeconomic goals, such as prospering economic growth, stable inflation, and low unemployment rates.
Spillin' the Beans on Aggregate Demand
Aggregate demand is the sum total of spending by the four sectors in the economy: household consumption, business investment, government spending, and net exports.
- Aggregate demand = Consumption + Investment + Government spending + Net exports
Economists point out that aggregate demand is influenced by several factors, with the price level bein' the key one. Other factors also include consumer and business confidence, exchange rates, household wealth, fiscal and monetary policies.
Unlike the price level, changes in these factors cause the aggregate demand curve to shift to the right or left. A change in the price level, though, merely moves the curve along. A rightward shift of the curve leads to an increase in real GDP, signifying a growin' economy.
Conversely, a leftward shift of the curve results in a decrease in real GDP, showin' a declinin' economy. In essence, shifts in aggregate demand have far-reachin' effects, impactin' not just GDP but also the inflation rate and unemployment level.
How does Fiscal Policy Influence Aggregate Demand and the Economy?
Economists categorize fiscal policy into two types:
- Expansionary (Loosenin') Fiscal Policy
- Contractionary (Tightenin') Fiscal Policy
Expansionary fiscal policy aims to boost economic growth. Governments deploy it when the economy is sluggish or in a recession.
In contrast, contractionary fiscal policy is used to temper inflationary pressures. High inflation creates turmoil in the economy and weakens growth.
Expansionary Fiscal Policy: Raisin' the Stakes
Governments execute expansionary fiscal policy by:
- Slashin' taxes
- Injectin' more spendin'
They often pull out both weapons simultaneously when necessary. In such cases, the federal budget deficit increases, and governments may cover the shortfall by issuin' debt securities.
The outcomes of these policies, if successful: an increase in aggregate demand, a rightward shift in the aggregate demand curve, and a bump-up in real GDP. The bump-up in real GDP means the economy is churnin' out more output. That, in turn, makes businesses expand production and hire more workers, lowerin' the unemployment rate.
Tax Cuts: Passin' the Savings onto Consumers
Tax cuts hit aggregate demand indirectly, as taxes aren't defined as part of the aggregate demand formula. Instead, they affect demand through their influence on household spending and business investment.
Tax cuts got folks with more money 'cause they pay less taxes. They got two ways to spend their extra dough: consumption and savings. The size of the impact on aggregate demand depends on how much of their extra cash they spending on consumption.
stairs up consumption? That, mates, increases the demand for goods and services. Businesses respond by increasin' production. If demand keeps growin', they start investin' and recruitin' more workers.
A Hike in Government Spendin': Hit the Bricks!
Changes in government spendin' affect aggregate demand directly. An increase in government spendin' boosts aggregate demand, causin' real GDP to jump up.
Government spendin' can also spur a multiplier effect on the economy. For illustration, the government boosts infrastructure spendin' on roads. It creates demand not only for construction goods and services but also jobs and income for households, further increasin' aggregate demand.
C'mon, combine fiscal and monetary policies like a pro!
References:
- Aggregate Demand: Gettin' the Formula and Impacts Straight
- Aggregate Demand Curve: Understanding its Slope and Determinants
- Net Exports: Learn how Trade Impacts the Aggregate Demand and GDP
- Household Consumption: Discover its Engine and Impacts
- Excess Capacity: Meanin', Measurement, Impacts, and Influencin' Factors
- How Household Wealth Affects Aggregate Demand and Economy
- How Monetary Policy Works and Impacts Aggregate Demand and Economy
- How Exchange Rates Influence Aggregate Demand and Economy
- Government Spendin' as a Tool for Fiscal Policy [Impacts on Aggregate Demand]
Fiscal policy, comprising of taxes and government spending, attempts to steer the economy towards high economic growth, stable inflation, and low unemployment rates by influencing aggregate demand, a measure that calculates the total spending by the four sectors in the economy: household consumption, business investment, government spending, and net exports. A rightward shift of the aggregate demand curve, resulting from expansionary fiscal policy via tax cuts or government spending increases, leads to an increase in real GDP, stimulating economic expansion and creating employment opportunities. On the other hand, contractionary fiscal policy, used to temper inflationary pressures, involves increasing taxes or reducing government spending, resulting in a decrease in aggregate demand, causing a decline in real GDP and potentially reducing inflation.
