Discover the essential roles of fiscal policy in managing the trade cycle and promoting economic stability. Learn how government spending and taxation can influence economic growth and stability.
Roles of Fiscal Policy in Trade Cycle
Fiscal policy can be used for economic stabilization i.e. to remove boom as well as depression. As during depression, if an easy fiscal policy is adopted i.e, government expenditures are increased, taxes are decreased and subsidies are provided to consumers and producers, they will the effect of increasing the level of Nl, prices, investment, output and employment. Accordingly, the depression could be controlled. On the other hand, during prosperity, if a tight increased and subsidies withdrawn, they will have the effect of decreasing the level of Nl, prices, investment, output and employment. Accordingly, the boom can be controlled.
Fiscal Policy in Inflation and Deflation:
- Role of Government Expenditures in Deflationary
Gap:
If basically, economy is operating below full employment, it can be removed the help of increasing government expenditures. The increased government expenditures, depending upon government expenditures multiplier will lead to increase. Nl many a time. Hence, deflationary gap could be removed.
- Roles of Taxes in Deflationary Gap:
In case the economy is operating at below full employment level, the decrease in taxes will have the effect of raising the level of income through increasing consumption and investment.
- Roles of government expenditure in Inflationary Gap:
If economy is basically operating at above full employment where there is inflationary gap in the economy, the decrease in government expenditure will lead to decrease Nl many a time depending up Kg. In this way, inflationary gap will be over.
- Roles of Taxes in Inflationary Gap:
If economy is basically operating at above full employment having inflation or inflationary gap, it can be removed by increasing taxes. The increasing in taxes depending upon the value of Kt will decrease Nl many a time.
Objective On Fiscal Policy:
The highestrobjection again fiscal policy is this that it leads to crowding out. It is expressed as: if at any time government expenditures are increased, while taxes and supply of money remain fixed, then increased government expenditures will met with the help of borrowings from banks, etc. In this situation, government will have to compete with the private sector. As a result, the rate of interest will rise. The increase in rate of interest will discourage the private investment. Through multiplier effect, Nl will decrease many a time Thus, on the one side, because of increase in government expenditures Nl increase on the other side.
because of decrease in private investment. Nl will decrease, as a result, Nl could not be increased to the desirable extent as a result of expansionary fiscal policy. This phenomenon is accorded as crowding—out. Moreover, monetarists think that demand for money curve is steep. When rate of interest rises, the demand for money will increase. On the other sided, as the investment curves is flat, an increase in the rate of interest will lead to a greater decline in investment, such fall in investment will lead to offset the expansionary effect of increase in government expenditures.
Fiscal Policy and Inflation:
As during inflation if taxes are increased, it will reduced disposable income and consumption of the people. If government keeps its expenditures fix the increased taxes means reduced sales of bonds to private sector by government. As a result, the price of the bonds will go up. As price of bonds and rate of interest will go down because of increase in prices of bonds. The person who are having bonds will get rich—may be equal to amount of taxes. If the bond holders spend much amount to lead over to the firms, the investment will rise. In this way , the decreased consumption expenditures due to increase in taxes will be offset automatically Hence, AD will not be controlled.
Expected Future Income:
According to the monetarists not only depends upon present income but also upon expected and permanent income. Therefore, to check inflation, if taxes are increased they will not reduce consumption. Accordingly, when taxes do not decreased AD, inflation will not be controlled.