Fiscal Policy

Fiscal Policy is a pure government play of tax rates (Income) and government expenditure (Spending). Monetary policy and fiscal policy both go hand in hand to maintain a productive economy and to have inflation under control. The fiscal policy shows the government’s proactiveness in taking care of the economy.

When in an economic slowdown, the government spends on the services provided or picks out projects that increase employment and other businesses associated, which increases employment, spending multiplier and other recovery measures. The other side, tax rates are lowered to retain money in the hands of private businesses and people, if more money is available people tend to spend them on goods that are more than to lead a normal life. Ex, People opt for private cabs instead of public transports, Weekend dinner or frequent vacations. The stimulus provided by both the measures, increase employment rate, boosts business, without much importance to demand supply increases, cheap capital availability. All these being said to be optimistic, the inflation is peaking and that’s the last number any central bank would take care in a depressed economy. An extreme inflation will blur the line of being a productive economy and inflation infection.

One disadvantage of the act of controlling the economic parameters is, the government or the central bank cannot control all the economic drivers at one time. Policies can only be structured to target certain needs of the economy like employment, inflation, lower lending rate, money supply, GDP any one as a major concern.

When a change in fiscal policy occurs the major effect should be on the majority of the population, middle class population. Those are the one who benefit from the tax measures because the middle class population pay the majority of the taxes.

Fiscal policy, Tax, Inflation and Unemployment

In an expansionary fiscal policy, unemployment decreases due to the demand in recovery and cheap capital availability, the industries suffer from shortage of labour and start recruiting. Coupled with a monetary expansion policy, the interest rates goes lower. If a government spends on infra (bridge) the builder, engineer, last level workers, drivers and construction good dealers are benefitted which is less compared to the spending and to the population of the country. Taxes are lenient and might enroute to salary hikes, per capita income increases, this is putting money in the hands of people increasing money velocity. Expansionary policies cannot be perpetual as inflation comes in check after returning to normal levels. In a high inflationary situation,

Poor get poorer rich get richer

In case of a contractionary fiscal policy, both the employers and employees are commanded to pay more tax than the usual as the economy has been over done with expansion. Arresting the liquidity by increasing short term lending rates, the economy slows down or get to the desired level. Inflation reduces and fear of deflation arises due to overstressing of fiscal policy tools like reserve ratio which makes capital scarce. At an extreme state unemployment increase due to economic scale of production in sectors that are labor intensive (manufacturing, power, automobile).

Any of the fiscal policy is over done, leads to disastrous consequences. If taxes are reduced and government expenditure is increased, inflation hits the roof. When put through a sieve, the sustainable growth is marginal compared to the price growth, which cannot sustain for a longer period of time. In the other case, when the economy is restricted by increased tax rates and reduced spending, it’s possible the economy could go under the bus of deflation which is more dangerous than inflation.

When an economy experiences deflation, demand for cash increases and people reduce spending because, deflation increases the value of money, which pushes even the most needed spending into the future, e.g., buying a smaller soap or reduced quantity of bread. Not many ways are left to kick start the economy other than waiting for the economy to naturally pick up. When the government spends the billions, the circulation of money will still be lower as people tend to acquire the infused money and get richer. Demand for money increases.

Inflation, Deflation and birth of bitcoin.