Governments all over the world use a number of tools in the form of macroeconomic policies to influence the direction of the economy. Over-all a macroeconomic policy aims to foster a stable policy environment that is able to support strong and sustainable economic growth. Economic growth results in the creation of wealth and the availability of jobs. This consequently leads to improved living standards for the population. There are three main macroeconomic policies that governments use towards this end. They are fiscal policy, monetary policy and the exchange rate policy.
In the advent of the current environment of government deregulation, fiscal policy is the only macroeconomic tool that is completely controlled by governments. Fiscal policy involves the level of government spending, the types of taxes levied to its constituents and the form of government borrowings. Government action in these areas influences various economic conditions.
When the economy slows down for example, governments may increase fiscal spending to increase economic activities. This is often called the stimulus package. Government spending can stimulate additional job creation and therefore can lead to a more vibrant economic condition over-all.
The ultimate goal of a fiscal policy is to achieve balance in the aggregate demand. Ideally, a government must have a balanced budget. That means that the government’s capacity to earn revenue in the form of tax collection is equal to the expenditure spent on government services. However, there will be times when governments choose to spend more or lesser than its revenue in order to control fluctuations in the aggregate demand.
When an economy contracts for example, taxes tend to shrink as companies and individual taxpayers realize lesser incomes. The logical consequence would be for the government to also cut on spending. However, they can choose to increase spending in unemployment benefits and other social programs. This way, the increase in government spending provides a counter weight to the decrease in private spending. Thus, the level of aggregate demand is maintained. For private individuals, this may also mean that income is lost due to the contraction of the private sector are recovered through social payments and support made by the government.
A stable aggregate demand ensures that total performance of the economy expressed in terms of aggregate domestic production is able to catch up with the forecasted growth. Conceptually, the uptrend in the economy tends to correct the deterioration in the government budget bottom line as economic conditions improve and private individuals are able to recover with the help of government subsidies given.
But fiscal policy does not only serve to correct short-term and cyclical economic fluctuations. Fiscal policy can also be framed to support long-term objectives. The current budget can provide for anticipated future demand. This includes expenditures for infrastructure to support further growth in the future, or expenditures on disaster management and clean energy to mitigate future impact of climate change to private businesses and individuals. This also includes government investment in education to ensure a competitive work force that will fuel the long-term growth and stability of the domestic economy.
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