Fiscal Policy Essay Example | Topics and Well Written Essays - 1750 words

Fiscal Policy - Essay Example From the research it can be comprehended that fiscal policy refers to the means used by the government in spending and taxation to monitor or influence the economy. In a way, the government has to adjust its level of spending to influence the economy. This fiscal instrument is used by the government each year to manage its economy for the benefit of the citizens. The tax implications on the nation’s budget have different inferences to different groups of people within society. Fiscal policy focuses generally on the fiscal changes in government revenue and expenditure and their impact upon nation’s economy. Tax and expenditure are the basic fiscal policy instruments. However, the most potent fiscal instrument used by a government is taxation. Taxation has led to reduction of consumption, increases investments, and allow for the transfer of government resources to economic development. Taxation has impact to the general level of output by altering the incentives that inst itutions encounter. Taxation is imposed by government to cut the cost of governance and communal services. Taxation also facilitates resource re-allocation, and enhances the promotion through equitable wealth distribution, to enhance economic growth and development. This also ensures economic stability by correcting and controlling macroeconomic shocks which are both policy-induced or exogenous. Hence, we are able to understand the gap between the level of expenditure and taxation. When the government revenue is high, the liquidity trap increases in the money supply, which does not contribute to the improvement of economic growth due to downward pressure experienced in investment (because of insensitivity of interest rate compared to money supply) (Alesina & Tabellini 2005). Likewise, this may also occur when the government expenditure surpasses revenue. The most important factor to consider in such a case is not the level of the deficit but the change that accompanies the deficit. Fiscal policy is an important instrument that is used to monitor government’s economy due to its impact on GDP (Alesina & Tabellini 2005). Fiscal policy has been associated with the use of taxation and public expenditure to influence the level of economic activities. The implementation of fiscal policy is channeled through government’s budget.   An important aspect of a public budget is its use as a tool in the management of a nation’s economy (Alesina & Tabellini 2005). During economic recession, the government plans for budget deficit which is often referred to as expansionary fiscal policy. In such a situation, taxes are reduced with a subsequent increase in the government expenditure, and during depression, or economic boom, the government may decide on a budget surplus to slow down the economy. This implies that through reduction in taxes, the purchasing power of individuals is enhanced and the cost of production of workers reduces, thereby improving thei r scale of operations in the business cycle. On the other hand, increases in public expenditure when effectively used can lead into improved developments in the nation’s infrastructure. Consequently, there is an increase in general welfare and places the economy on the path of growth. This explains the first impact of fiscal policy on improving the demands for goods and services. The aggregate demands make it an important instrument for a government’s economic stabilization. Fiscal growth has affects the output level and has implications on a country’s savings. Thus, in fiscal expansion, the government will be forced to reduce savings, which is equivalent to a budget surplus. The reduction in fiscal deficits may lead to increase in domestic production. Furthermore, it may lead to stable exchange rate that should be pursued as means of controlling inflation in a nation. 2. With the aid of a diagram, show and explain how fiscal policy can be used to shift