) Fiscal policy refers to changes in governmentexpenditures and / or taxes to achieve economic goals, such as lowunemployment, price stability, and economic growth. It isthe use of government revenue collection (mainly taxes)and expenditure (spending) to influence the economy. Accordingto Keynesian economics, when the government changes the levels of taxationand government spending, it influences aggregate demand and the levelof economic activity. Fiscal policy is often used to stabilize the economy overthe course of the business cycle. Thus, I would like to suggest two typesof fiscal policy that can be implemented to have a sustainable GDP growth whichare automatic fiscal stabilisers and discretionary fiscal policy. Automaticfiscal stabilisers are economic policies and programs designed to offsetfluctuations in a nation’s economic activity without intervention by thegovernment or policymakers on an individual basis.
The best-known automaticstabilizers are corporate and personal taxes, and transfer systems suchas unemploymentinsurance and welfare. Automatic stabilizersare so called because they act to stabilize economic cycles and are automatically triggered without explicitgovernment action. For instance, progressive income taxes, this is the type oftax that increases when income of a person increases.Progressive taxation push people into higher income tax brackets during boomtimes, substantially increasing their tax bill and reducing government budgetdeficits (or increasing government surpluses).
During recessions, manyindividuals fall into lower tax brackets or have no income tax liability. Thisincreases the size of the government budget deficit (or reduces the surplus).Whereas for discretionary fiscal policy, it is the non mandatory changes ingovernment expenditures and taxes that need specific approval from the Congressor the President in response to economic events or changes in economicconditions. Discretionary fiscal policy often occurs in period of recession oreconomic turbulence. For example, increases in spending on roads, bridges,stadiums, and other public works in an attempt to lower the unemployment rate.On the contrary, the national income will increaseif the government is running a budget deficit. This is because GDP will rise ifaggregate expenditure exceeds GDP. Government Budget is a detail accounting for the income received bythe government such as people who pay the taxes and fees and the paymentsgovernment made such as purchases and transfer payments.
A budget deficitoccurs when the government spends more than what they receive.Abudget deficit means that government expenditure which is an injection isgreater than taxation which is a withdrawal. Besides that, budget surplus is the opposite of the budgetdeficit which is taxation greater than government expenditure.
When the governmentrunning a budget deficit and the government expenditureincreases, it will directly proportional influence the national income sincegovernment expenditure is one of the determinants for equilibrium level ofnational income. This occurs based on the formula, national income = totalexpenditure ( consumption + investment + government expenditure)It is difficultto fine tune the economy by using fiscal policy because there are a fewobstacles that are against it. One of theobstacles is time lag because if the scheme of the government is increasing thespending and this may take a long time process to filter into the economy ormay be too late. Spending plans are only setting once a year, so there willcertainly be a delay in implementing any changes in government plans.After that,fiscal policy decision needs approval by the government and this will requirea longer time to approval.So, that is why decisions are not taken at propertime and this will cause time lag. Besides,the multiplier effect also is an obstacle tofiscal policy because fiscal policy is depending on multiplier effect.Thefiscal multiplier effects occur when an initial injection into an economy andcause a larger final increase in national income.
So, increase the multipliereffect may have any changes in injections and the size of the multiplier willbecome larger.If the income increase,the multiplier effect will be low and theeffectiveness of fiscal policy will also be reduced.In expansionary policy, theextent to which government spending and tax cuts increase aggregate demanddepends on spending and tax multipliers.The spending multiplier is bigger thanthe tax multiplier because the entire increase in government spending isachieved by increasing aggregate demand, but only a portion of the increase indisposable income (due to the lower taxes) is consumed.So,the multiplier effectof a tax cut can be affected by the size of the tax cut, the marginalpropensity to consume.Fiscal policy will suffer if thegovernment has poor information.Poor information gives rise to poor decisionand a decisions cannot be better than the information on which they are based.Poor information also can have very serious consequences such as affect theeconomic growth For example, if the government assumed there is going to be aninflation next year and they will decrease the aggregate demand.
However, ifthis prediction was wrong and the economy grew slowly, the government actionwould cause the recession.Furthermore, the fourth obstacle isside effects on public spending. If thegovernment decide to reduce government spending (G) to decrease inflationarypressure, the government spending can harm long -term productivity. Thegovernment spending involves investment in increasing capital stock and productivecapacity, such as building new roads, public transport and education and thiscause market failure and social inefficiency. Then, lower the government alsowill lead to lower the economic growth. Also, it will be difficult to reducespending in the future. If the government chooses to reduce government spending(G) to decrease inflationary pressure, it could adversely affect publicservices such as public transport and education causing market failure andsocial inefficiency.
The last obstacle is crowding out. Crowding out occurswhen expansionary fiscal policy of increased government spending (G) and willnot increase the aggregate demand or increase slowly .For example, if thegovernment spending increase , because they borrow money from the privatesector, so private sector will reduces private sector investment and spending.However, private saving rates rise quickly during the recession. Thus, anexpansionary fiscal policy helps to counteract the rises of private sectorsaving and put money into the circular flow so will not cause any crowding out.