HOW THE GOVERNMENT CAN USE FISCAL POLICY TO STABILIZE THE ECONOMY
In economies, every booms and peaks are followed by recessions. Due to the fact that many people lose their jobs in these recession times (especially after the 1929 World Economic Crisis) the idea that government should interfere the economy for decreasing fluctuations; has widely accepted since John Maynard Keynes. In addition, to prevent excess price fluctuations, fiscal and monetary policies can be used.
Keynesians believe that macroeconomy is likely to fluctuate too much if left on its own and that the government should play an important role in stabilizing the fluctuations in the business cycle. According to the book The General Theory of Employment, Interest and Money, which was written by J. M. Keynes, government can use its taxing and spending powers to increase aggregate expenditure in times of recessions and depressions.
Governments play a very important role in the economies of all countries. They can affect the macroeconomy in two ways: ·
Monetary Policy ·
Fiscal Policy
Monetary policy means the tools the government uses to control the money supply but it is not mentioned in this study. Fiscal policy refers to the government's spending and taxing behavior. It is divided into three categories:
1. Policies concern with government purchases of goods and labor
2. Policies concern with taxes
3. Policies concern with transfer payments to households.
WHY THE GOVERNMENTS USE FISCAL POLICY?
A. to stabilize the economy: Governments should consider two things for stabilizing the economy: price stabilization and full employment. In this case, fiscal policy will be resist some economic leaning to stabilize the economy:
I. resisting the deflationary situations
II. resisting the inflationary situations
III. keeping the full employment
B. to provide the economic growth: Fiscal policy plays a very important role for actualizing economic development.
C. for better living standarts and distribution of wealth: The unfair distribution of wealth causes the different living standarts and uneasiness among people.
GOVERNMENT PARTICIPATION IN THE ECONOMY
Any policy that aims to stabilize national income is called stabilization policy. It consists of government actions to try to keep output close to its full-employment level. If the government has an aim about the economy, it can use taxes and expenditure as tools to push the economy toward that aim. For example, in recession times; governments want to increase national income by raising expenditures or lowering taxes.
THE FORMATION OF FISCAL POLICY
Fiscal Policy has been differentiated according to the budget deficit or budget surplus. It is related to taxes and expenditures. If taxes are less than expenditures, then we will come to a new object: getting into debt. As a result, these three statements had become the tools of fiscal policy.
Figure 1: Economics Policies; Fiscal Policy and Factors of Production
GOVERNMENT PURCHASES AND EQUILIBRIUM INCOME
If government decides to increase or decrease its spending, the eqilibriun income changes. Suppose that it decides to saving $ 2 billion a year at every level of income, as a result aggregate expenditure (AE) curve shifts downwards by the same amount. Changes in equilibrium income can be calculated using multiplier.
Government Spending Multiplier : It is the ratio of the change in the equilibrium level of output to a change in government spending.
It means an increase in government spending causes in equilibrium output to increase by the change in G times the government spending multiplier.
DY = DG X (1/ MPS) (D means "changes in...")
TAX POLICY AND EQUILIBRIUM INCOME
Table 1: Derivation of Consumption Schedule with Income Taxation
It can be seen in Table 1 that for every different value of GDP, there are different disposable income and consumption levels. Tax rates and disposable income are related negatively. When tax rates change, the relationship between desired consumption expenditure and national income changes. It causes and upwards shift on aggregate expenditure curve, it is an increase in the slope of the curve.
Figure 2: The Effect of Changing The Tax Rate
The Tax Multiplier : It is the ratio of change in the equilibrum level of output to a change in taxes.
BALANCED BUDGET CHANGES
Governments can change spending and taxes equally to make a balanced budget. A balanced budget increase in
government expenditure will have a little expansionary effect on national income and a balanced budget decrease will have
a little contractionary effect.
Balanced Budget Multiplier : It is the ratio of change in the equilibrium level of output to a change in
government spending where the change in government spending is balanced by a change in taxes so as not to create any deficit.The balanced budget multiplier is
equal to one: The change in Y resulting from the change in T is exactly the same size as the initial change in G or T itself.
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