Fiscal Policy (Definition, Objectives, Effectiveness)
Fiscal Policy is used to influence aggregate demand. This is a tool that comprises Government Spending and Taxation that government uses to either increase or decrease the aggregate demand.
Fiscal Policy is of two types: Contractionary and Expansionary budgetary policy. Expansionary fiscal policy is when government spending is increased and taxation is decreased. This will stimulate spending in an economy which will increase aggregate demand and will shift to the right. This will help the economy to obtain economic growth and also helps increase employment. The government most uses this to close the recessionary gap i.e.: when potential GDP is more significant than actual GDP.
Contractionary policy on the other hand is when government spending is decreased and taxation is increased. This will reduce spending in an economy, decreasing aggregate demand and shifting it to the left. The government uses this policy to correct an economy with an overheating economy. It is also used to close the expansionary gap i.e.: when actual GDP is more incredible than potential GDP.
But the thing is, will this policy always work? While implementing such tools in the economy the government mostly faces the issue of time lag. The monetarists believe that crowding out of funds occurs. They believe that increased public-sector funding crowds out private-sector funding. On the other hand, Keynesians believe that Crowding in funds occurs. This implies that increased public sector funding crowds in private sector funding. Sometimes increased taxation will demotivate firms to produce more as this will increase their cost of production. Hence the effectiveness is mostly questioned.
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