Do Fiscal and Monetary Policy Stimulate the Economy? Essays

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Constant changes in market economies make it nearly impossible to maintain a constant level of economic activity. Fluctuations are the heart of market economies; market economies cannot exist without them. These fluctuations can be described as the business cycle, and like every cycle there are a series of events that construct these phases. The business cycle consists of three phases, expansion (until peak point is reached), a decreasing point into recession, and a rebound from recession to recovery. These events must be examined closely because it is possible for the economy to hit extreme highs and extreme lows which can abruptly change the flow of the cycle. For example, if overlooked and the economy hits an extreme low, considered a…show more content…
The government can use the fiscal policy to lower taxes and increase the level of government expenditure to boost the economy when facing a recession. Lowering taxes and increasing the level of government expenditure encourages individuals to spend more. When the government lowers indirect taxes, goods will become cheaper because their taxes will be lower resulting in a higher demand for these goods. Similarly, if direct taxes are lowered, disposable income increases which encourages spending. In both cases, lowering either direct or indirect taxes during a recession, increases demand which will eventually help the economy out of recession due to encouraged economic growth. In contrast, if the economy is already at full employment, an increase in fiscal expansion will affect prices more than it will impact total output. When the economy is not in a recession and is facing a “boom” in the economy, inflation becomes the problem. If the economy is facing inflation, the fiscal policy can be used to produce a budget surplus and help slow down the economy. Despite the fact that the fiscal policy can be applied at times of recession or at times of inflation, the fiscal policy has some flaws. Law-making time lag, shrinking area of lawmaker discretion, estimation of potential GDP, and economic forecasting are all factors that interfere with the effectiveness of the fiscal policy. First, the law-making time lag, this flaw can
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