Fiscal Policy And Its Impact On Aggregate Demand And Aggregate

Question: Discuss about theFiscal Policy And Its Impact On Aggregate Demand And Aggregate Supply. Answer: Introduction This essay highlights on the fiscal policy and its impact on the aggregate demand and aggregate supply in a particular economy. This topic is analyzed based on the article of UK s budget deficit that increases this year amid squeezing living standards of people. Fiscal policy denotes the use of respective nations government budget to influence the economy. This mainly includes government expenditure and levied taxes. Fiscal policy is of two types- expansionary and contractionary. Expansionary policy increases budget deficit while contractionary policy decreases budget deficit. Fiscal Policy influencing aggregate demand and aggregate supply The article highlights that the government expenditure deficit is going to worsen in the present year as the figures shows that the slowdown in economy has been starting to take toll on public finances of UK. It has been stated by some analyst that the UK government will fail in meeting the plan of decreasing budget deficit each year. Fiscal policy signifies the use of taxing as well as governments spending powers to impact oneconomic outcome (Arestis 2012). The fiscal policy adopted by the government sometimes includes deficit spending in order to enhance aggregate demand in the respective nation. The budget deficit refers to the shortfall between expenditure of government and tax revenue. This deficit is basically funded through sale of government bonds to private sector. Expansionary fiscal policy occurs when expenditure increases or taxes lowers while contractionary fiscal policy occurs when government spending decreases or tax rises. However, expansionary fiscal policy increases budget deficit while contractionary policy decreases deficit (Jaramillo and Cottarelli 2012). In this article, it has been stated that deficit in UK government spending is going to reduce in this year, which reflects that UK government has imposed contractionary fiscal policy in order to combat rising inflation. Implementation of this policy has also been done for reducing sovereign debt, asset bubbles and out-of-control growth. Fiscal policy mainly concerns on the change in government expenditure and taxation (Corsetti et al. 2013). This policy influences both the AD and AS, but the influence on AD is direct while the effect on AS is indirect. AD refers to the summation of consumption, investment, government expenditure and net export (AD=C+I+G+(X-M)). Rise in government spending increases AD that in turn influences the economy. This leads to rise in output as well as prices, considering other things constant. The degree of rise in price is generally based on elasticity of AS. If AS is elastic, rise in output results in inflationary pressures. On the contrary, if AS is inelastic, rise in government spending causes risk of overheating. Some fiscal policy changes can affect the aggregate supply in direct way, which includes- capital expenditure, R$D innovation etc. According to the macroeconomic model, if government raises their spending or decreases taxes, both the aggregate demand (AD) and aggregate supply (AS) of the respective economy increases and hence shifts to right (Afonso and Sousa 2012). However, this causes the business organization to expand in the global market and hence enhances the economic growth of nation. On the other hand, if government reduces spending or increases tax, the aggregate demand will increase but aggregate supply will decrease. However, AD curve will shift to the right while AS curve will shift to left. This is shown in the diagram below: Figure 1: Contractionary fiscal policy affecting AD and AS Source: (As created by author) Conclusion It can be concluded from the above essay that the government imposes fiscal policy in order to stabilize the economic growth. The fiscal policy is basically implemented by the government of the respective nation in order to combat with recession, inflation level and unemployment rate. Moreover, this policy influences both the AD and AS of the economy which are considered as the drivers of economic growth. References Afonso, A. and Sousa, R.M., 2012. The macroeconomic effects of fiscal policy.Applied Economics,44(34), pp.4439-4454. Arestis, P., 2012. Fiscal policy: a strong macroeconomic role.Review of Keynesian Economics. Corsetti, G., Kuester, K., Meier, A. and Mller, G.J., 2013. Sovereign risk, fiscal policy, and macroeconomic stability.The Economic Journal,123(566). Jaramillo, L. and Cottarelli, M.C., 2012.Walking hand in hand: fiscal policy and growth in advanced economies(No. 12-137). International Monetary Fund.