Question

What are the two basic “tools” of Fiscal Policy, and what would be the ultimate purposes to justify using these tools? Discuss the controversy concerning which types of fiscal policies to use, including the arguments from the Keynesians as well as the Supply-side branch of economics, providing examples of each, evaluating the effectiveness in each example you provide.

Answer 1

Two basic tools of fiscal policy are taxation, government expenditure and debt. When the economy is not self correcting or we can say, in situations where the market forces are not able to correct the market, government intervene in the market to help doing so. And the tools that are being used to influence the market by influencing demand and supply forces are government expenditure and taxes. When there is surplus in the economy government imposes taxes and eliminate the surplus and inflation. When there is deficit or depression in the economy government uses expenditure tool and increases moneysuply and there by increases the effective demand in the economy.

There are also two types of fiscal policy- expansionary and contractionary. Expansionary fiscal policy is used when there is depression in the economy. Contractionary fiscal policy is used when there is surplus or inflation in the economy. But if we will take into consideration the views of Keynes and the classicals, it's not the same. As Keynes always argued as a demand side economist, according to his views expansionary fiscal policy will help eliminate the discrepancy in the economy by influencing the effective demand, contractionary fiscal policy is also helpful when the economy is in inflationary trap. But according to classicals a free economy is preferable for the Society and government intervention should be minimal in economic affairs. They believe so because, according to them market discrepancies are self correcting and government expenditure creates crowding out effect in the economy, so minimal government intervention is preferable.