Monetary policy and fiscal policy

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categorie: Engleza

nota: 10.00

nivel: Liceu

Fiscal policy, by contrast, operates in a manner that depends on precisely what gods the government buys or what taxes and transfers it changes. Here we might be talking of government purchases of goods and services such as defense spending or a reduction in the corporate profits tax, sales taxes, or social security contributions.

Each policy affects the level of aggregate demand [...]
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Fiscal policy, by contrast, operates in a manner that depends on precisely what gods the government buys or what taxes and transfers it changes. Here we might be talking of government purchases of goods and services such as defense spending or a reduction in the corporate profits tax, sales taxes, or social security contributions.

Each policy affects the level of aggregate demand and causes an expansion in output, but the composition of the output increase depends on the specific policy. An investment subsidy increases investment spending. An income tax cut has a direct effect on consumption spending. All expansionary fiscal policies will raise the interest rates if the quantity of money is unchanged.

When we speak of fiscal policy, we are referring to these public tax and expenditure activities; more particularly, fiscal policy is the use of the government's taxation and spending powers to alter macroeconomic outcomes.An increase in government spending has a multiplied impact on total spending. The government expenditures in product markets create additional income. This added income finances increased consumption. These income and spending cycles continue until total income (spending) has increased.

Stimulus to the circular flow of income is made of:
1.increased employment
2.additional income
3.increased consumption
4.increased sales receipts
5.increased govern spending
which are represented in the next figure.

Fiscal policy will not always be used to increase aggregate spending. Just as the expenditure decisions made by consumers and investors may result in deficient aggregate spending, so too may they result in excessive aggregate spending.

In situations where excessive spending threatens to erode price stability or is already doing so, the objective of fiscal policy is to decrease total spending rather than to increase it. In this sense, fiscal policy is a two-edged sword, which may be used either to stimulate or to suppress aggregate spending; but a major objective of this policy is to close inflationary and recessionary gaps.

Fiscal policy affects aggregate demand and thus has an impact on output and income; but changes in income affect the demand for money and thereby equilibrium interest rates in assets markets; these interest rates change feed back to the goods market and dampen the impact of fiscal policy.

The recognition that monetary and fiscal policy changes have different effects on the composition of output is important. It suggest that policy makers can choose a policy mix that will only get the economy to full employment but also make a contribution to solving policy problems.
The use of fiscal policy to alter the level of GNP is commonly referred to as the stabilisation function of the budget.

The basic objective of such activity is to stabilise total spending at a rate that is consistent with the goals of full employment and price stability. (The Keynesian theory of instability leads directly to a mandate for government policy. From a Keynesian perspective, an insufficiency of aggregate spending causes unemployment; an excess of aggregate spending causes inflation. Since the market itself will not correct these imbalances, the government must.

How is possible that fiscal policy has no effect at all on income? After all, of the government were to spend more, how is it possible that the increased spending should not raise income? The reasoning is as follows: an increase in government spending does lead to an incipient rise in aggregate demand and income, but that immediately raises the demand for money; with the money supply unchanged, interest rates will shoot up to clean the money market; as interest rates rise because of the excess demand for money, investment spending declines; the fall in investment spending compensates exactly for the higher government spending and the level of income is unchanged.
Does it matter how much money is available? Will the money supply affect our ability to achieve full employment, price stability or any other macroeconomic goal?

Vladimir Lenin thought so. The first communist leader of the Soviet Union once remarked that the best way to destroy a society is to destroy its money. If a society's money became valueless, it would no longer be accepted in exchange for goods and services in product markets. As a consequence, people would resort to barter, and the economy's efficiency would be severely impaired. Adolf Hitler tried unsuccessfully to use this weapon against Great Britain during the Second World War.
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