Understanding Fiscal Policy: Tools, Stances, and Objectives

Running Head: ECONOMIC ASSIGNMENT
Economic Assignment
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1ECONOMIC ASSIGNMENT
Fiscal policy is one instance of macroeconomic policy used by the government to achieve
different policy objectives. The fiscal policy suggests use of two main tools of taxation and
government expenditure in order to influence economic activity. John Maynard Keynes first
proposed intervention of government to stabilize the economy. Government often uses fiscal
policy to stabilize state of the economy in the phase of business cycle fluctuation. The
adjustment made through altering taxation and government expenditure, government can
influence key macro variables such as aggregate demand, saving, investment and income
distribution (Agénor and Montiel 2015). The fiscal policy is administered by a group of
government body following a particular law of legislature.
Government uses fiscal policy to counter economic fluctuations. In times when
government takes fiscal action to combat business cycle fluctuation then it is called discretionary
fiscal policy. Discretionary fiscal policy is adapted during rising inflation and level of
unemployment. Another important instrument used under fiscal policy action is automatic
stabilizers. The automatic stabilizers correspond to transfers and taxes that changes automatically
depending upon state of the economy. For example, during economic downturn spending made
on food stamps increases automatically because more people uses it (Mankiw 2014). Addition
spending on food stamp then softens the economic downturn by helping those receiving benefits
from food stamp. The policy automatically helps to expand businesses where money is spent.
The three stances of fiscal policy include expansionary fiscal policy, contractionary fiscal
policy and neutral fiscal policy. Expansionary fiscal policy is undertaken during economic
contraction. This is the time when economic growth slows down along with a decline in price
level and employment. In order to stimulate the economy aggregate demand needs to be