Effects of a Fiscal Policy

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Effects of a Fiscal Policy

Fiscal policy is where the government uses its expenditure and taxes to stabilize the economy. A good example is president Bush’s tax cuts which were introduced to close recessionary gaps and stimulate aggregate demand. Governments use the effects of fiscal policies to shift aggregate demand and supply either to the left or right. If a government makes a reduction in taxes and makes an increase in payments and purchases, then the aggregate demand curve will be shifted to the right. If the government increases taxes and reduces government payments and purchases, then the aggregate demand curve will shift to the left.

When consumers feel more confident about the future of the economy, they tend to spend more thus demand increases shifting the curve to the right. When the government of George Bush decided to reduce taxes, a lot of businesses in America took the opportunity and invested in their companies. Since the people were going through hard times and daily expenses were rising, then the government felt the need to relieve the people from high taxes which later on will have a positive impact on the economy (Alesina, Alberto, et al., pg. 21) Also, as a result of tax cuts, there was an increase in consumption demand which also shifted the AD curve because both consumption and investment are components of demand.

As a result of increase in investments and consumptions accompanies by increased government purchases and expenses the aggregate demand rose. Many businesses realized profit as well as government since people took advantage of reduced taxes and made allot of purchases. The effects of the policy increased aggregate supply and with time. The economy of America rose.

Aggregate Demand/Aggregate Supply model graph

Explaining the graph above, the original equilibrium when the economy is low is at point E0 which relatively away from the stable level of output. The tax cuts, increases consumption, shifting the aggregate demand curve to the right. E1 becomes the new equilibrium, real GDP then rises and factors that drags the economy behind such as unemployment then falls (Arestis, and pg. 12) Even though from the diagram the economic level has not reached its potential, it is expected to keep rising as a result of increased consumptions.

Works Cited

Alesina, Alberto, et al. The effects of fiscal consolidations: Theory and evidence. No. w23385. National Bureau of Economic Research, 2017.

Arestis, Philip, and Malcolm Sawyer. “Reinventing fiscal policy.” Journal of Post Keynesian Economics 26.1 (2003): 3-25.