Question

Fiscal Policy is another way to affect the economy. Functional finace proposes that governments should make spending and taxing decisions based on their effect on the economy.   

Give an example of a fiscal policy and the intended goal of the policy.

Do you agree that the government should make taxing and soending decisions based on what the economy needs in terms of expansion or contraction? Explain.

Answer 1

Fiscal policy is the discretionary policy of the government of using it spending and the tax rates to influence the aggregate spending in the economy. An example of fiscal policy is increase in the income tax rate or corporate tax rate. Similarly government can increase its spending on purchase of goods and services, unemployment insurance and other transfer payments. These are government initiated policy changes and therefore are a part of fiscal policy. While increase in the tax rate and decrease in the government spending are intended to reduce the aggregate expenditure and therefore the real GDP in the economy, a decline in the tax rate and an increase in government spending are aimed towards increasing the real GDP of the economy

Government should take fiscal policy decisions based on the needs of the economy. This indicates that whenever there are recessionary trends and the real GDP falls short of its full employment level, government should use fiscal expansion by decreasing the tax rate and increasing its spending. Similarly when there is an expansion going on in the economy, government should use contractionary fiscal policy.