In Fiscal Policy central government uses the government earning & taxation to stabilize the economy time to time by influencing macroeconomic factors like aggregate demands, employment, inflation & economic growth.
To increase the economic growth & reduce the unemployment, the government either increase their public expenditures like constructing new roads, airports etc. or cut the taxes to boost purchasing power of public which leads to increase in the aggregate demand in the economy, this ultimately raise the employment rate.
Key Points of Fiscal Policy
- It influences the aggregate demand to stabilize the economy.
- There are two types of fiscal policy, Expansionary and contractionary.
- In expansionary fiscal policy the government either lower the taxes or increase the public expenditure to boost the aggregate demand.
- In Contractionary fiscal policy government either increase the taxes or reduce the public expenditure to reduce the aggregate demand
- Fiscal policy is based on the suggested theory of British economist John Maynard Keynes
According to the British economist John Maynard Keynes (1883-1946) government can stabilize the economy more efficiently by adjusting the government expenditures & taxation than economy do by itself. This theory is developed by Keynes after the great recession in US & known as Keynesian Economics.
In Keynesian economics, Aggregate demand can influence the economic growth more effectively. Aggregate demand is a combination of consumer spending, business investment spending, net government spending & net exports.
What is the role of Private sectors?
According to Keynesian economics, private sectors component of aggregate demand is excessively variable & extremely dependent on psychological & emotional factors to stabilize the economy. Any type of fear & uncertainty exists between consumer & business can decrease the aggregate demand & slow down the growth of the economy that can cause recession & depression in the economy.
So, according to Keynesian economics a government can stabilize this situation by increase in the government spending like public infrastructures that’s boost employment & wages and reduce the taxation so that public can have more funds to spend & invest, to grow economy & normalize the recession effects.
Types of Fiscal Policy
- Expansionary: – In the time of recession or economic slowdown, Central government increase the government spending or reduce the taxes to increase the purchasing power of public that’s lead the aggregate demand in the economy & companies will invest more & hire more to fulfill that demand & this process leads to grow the economy & the employment rate, with also high inflation rates.
- Contractionary: – In opposite of Expansionary policy, government reduce the public expenditure & increase the taxation to cool down the aggressive growing economy & inflation rates, it is less applicable in practical life due to less political interest.
Fiscal Policy Vs Monetary Policy
Fiscal Policy refers to the steps to stabilize the economy by adjusting aggregate demands & taxes.
Monetary policy uses by central bank of the country to adjust the money supply in the economy.
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