Fiscal Policy

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The economy fluctuations in today’s world have become one of the most important factors in determining the direction of an economy growth. Non-stable economy can harm and slow the development and growing rate of a nation. There are many tools to stabilize the economy and reduce the frequency and the altitude of economic fluctuations. Among these tools are the fiscal policy and monetary policy. This report discusses the fiscal policy and why the governments use this too to stabilize the economy and encounter the economic fluctuations.

Fiscal policy is a macroeconomic tool used by the government through the control of taxation and government spending in an effort to affect the business cycle and to achieve …show more content…

At E¬¬1 the economy is under its full employment equilibrium Y¬¬F¬. The expansionary policy stimulates the AD1 and restores the equilibrium again at E2.
In the times of inflation, the economy operates above its full potential output and the government tries to raise taxes. When the government raises taxes, consumers are forced to put a larger portion of their income toward taxes, and thus disposable income falls. In terms of the economy as a whole, this is represented by Y = C(Y - T) + I + G + NX where an increase in T results in a decrease in Y, holding all other variables fixed. When the government reduces government spending, the recipients of government spending, the populace, have less disposable income. In terms of the economy as whole, this is represented by Y = C(Y - T) + I + G + NX where a decrease in G results in a decrease in Y. Contractionary fiscal policy makes the populace less wealthy and decreases output, or national income.
The contractionary fiscal policy tends to bring down the total income to its equilibrium. This is shown in the following figure that illustrates how the contractionary policy affects the aggregate demand curve.

Figure 2: The effect of the contractionary fiscal policy on aggregate demand
During the inflation times, the strong demand such as AD¬1 will temporarily lead to an output rate beyond the economy’s long-run potential YF. Contractionary fiscal policy could

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