Fiscal Policies and Stabilization of the Economy

Fiscal Policies and Economic Performance

Fiscal policies refers to the various instruments the government used in the bid to influence the aggregate demand and other macroeconomic variables. Some of the economic variables that are determined by the fiscal policies include real GDP, unemployment, and inflation. In this regard, two economic situations are used to describe a country’s state of economic performance (Carnot and Francisco 63). The two situations are recession and boom, where the formers are characterized by high rates of unemployment, low inflation rates, and shrinking GDP, while the latter is characterized by high inflation, low unemployment rate, and growing GDP. Therefore, this paper focuses on the appropriate fiscal policies that can be recommended to stabilize the economy during a boom with high inflation, low unemployment rate, and increasing economic growth.

Recommended Fiscal Policy Measures

The most suitable fiscal policy measures that should be adopted by the government are to increase taxation and reduce government spending which is obtained by running a surplus. These two measures will be able to reduce the aggregated demand in the economy which influences the level of inflation. The problem of inflation occurs when the aggregate demand in an economy exceeds the aggregate supply, thus leading to high prices since the prices are set by firms (Easterly and Sergio 430).

Since total demand is a function of government spending, consumption, and investment; reducing government expenditure up to the required full employment level will lead to a decrease in public demand for goods and services which in turn lowers the aggregate demand. Similarly, an increase in tax will reduce the disposable incomes of people hence decreasing their consumption leading to a decrease in aggregate demand. Therefore, the economy stabilized since the level of inflation will be reduced, and the unemployment rate maintained at the natural rate (Carnot and Francisco 63).

Works Cited

Carnot, Nicolas, and Francisco De Castro. “The discretionary fiscal effort: an assessment of fiscal policy and its output effect.” Hacienda Pública Española 215 (2015): 63.

Easterly, William, and Sergio Rebelo. ”Fiscal policy and economic growth.” Journal of monetary economics 32.3 (2007): 417-458.