Fiscal Policy, Depressed Economy - Assignment Example

1. An economy goes through ups and downs which are referred to as expansion and recession phases. These phases have an effect on the overall growth of the economy which is reflected on the level of employment, inventories, money in the system and plant utilization. The different phases of a business cycle is shown below (Business Cycle. 2012) The economy shows different results in different scenarios. Considering the expansion phase which is one where the economy is growing at a rapid pace. During this phase people in the economy have a positive sentiment and are of the view that the income level will rise in the future. This results in increased spending and less of savings. Increased spending results in more money in the economy and the increased demand for goods and services makes the manufacturer to produce more of the goods and services. To produce more goods and services more people have to be hired which results in a reduction in unemployment. The fact that the capital requirement cannot be changed in the short run and requires some time before making changes in the capital requirements the manufacturing units have to ensure that more and more employees are employed which makes the machinery and other capital units to run at maximum capacity utilization (Mayerhoefer & Zuvekas, 2008). The overall effect is such that it results in increasing the demand for goods and services as the employees who are compensated for their services look towards purchasing the goods and services from the market. This results in a cyclical effect and continues till a point where the goods are produced at maximum capacity and after that result in an increase in the price level due to additional demand for goods and services which can only be compensated by an increase in price as shown below (Garg, 2010) Thus, in case of expansion phase the economy witnesses widespread growth and results in reducing the unemployment level, the inventories level come down and the entire industry is able to operate at maximum capacity which ensures positive growth rate and the economy is able to move at a faster growth rate. Considering the recessionary phase which is one where the growth rate of the economy is continuously falling. During this phase people in the economy have a negative sentiment and are of the view that the income level will fall in the future. This results in decreased spending and more of savings. Decreased spending results in less money in the economy and the decreased demand for goods and services makes the manufacturer to produce less of the goods and services. This results in people loosing jobs and the unemployment level starts to rise. The fact that the capital requirement cannot be changed in the short run and requires some time before making changes in the capital requirements the manufacturing units have to ensure that less and less employees are employed which makes the machinery and other capital units to run at lower than maximum capacity utilization. The overall effect is such that it results in decreasing the demand for goods and services as unemployment level is high and people fear the same in the near future due to which they start to hoard money. This results in a cyclical effect and continues till a point where the goods produced are decreasing and results in piling up of inventory along with the additional pressure of job losses and reducing prices so that the goods which are produced can be sold (Colell, Winston, Michael & Jerry, 1995). Thus, in case of recessionary phase the economy witnesses fall in the growth rate and results in reducing the employment level, the inventories level rises and the entire industry is operates at a lower than capacity utilization which further has an effect on the performance and makes the economy witness negative growth rates. 2. A depressed economy is one where the people have negative sentiments both about their future growth potential and the growth potential of the economy. It is a situation which highlights an increase in the unemployment level, the spending by the consumer is down and the business is unable to make money. This situation makes the economy loose the long term growth potential as slow growth rates and decreasing employment rate has a negative effect on the overall potential of the economy. This situation requires that the government looks towards supporting the economy and developing ways through which they are able to transform the economy and bring about changes in the mind set of the people. Government has to look towards using fiscal policy in case of depressed economy so that they are able to bring an impact on the overall condition. Fiscal Policy is one where the government looks towards making changes in their spending level so that more and more money can be pushed in the economy which will stimulate demand and needs to monitor the situation closely so that the economy is able to grow. In case of a depressed economy the unemployment level is high, the consumer spending is low and the business is unable to make profits. This will require that the government looks towards resorting to fiscal policies by increasing their public spending and reducing the tax rates. This will have an effect on the depressed economy in the following way. Reducing the tax rate and increasing the public spending will result in increasing the money supply within the system. Reducing the tax rate will make the people pay fewer taxes which will thereby ensure that they have more income at their disposal which can be used to purchase goods and services. The increased demand for goods and services will increase the level of employment as organizations will have to look towards hiring more employees. This will result in increasing the demand for goods and services and will create a positive impact on the economy. Similarly increasing the government spending on public purposes like building roads, bridges and others will increase the level of income for the people through which more goods and services can be produced. The increased demand for goods and services will increase the level of employment as organizations will have to look towards hiring more employees. This will result in increasing the demand for goods and services and will create a positive impact on the economy (Shepherd, 2006). Thus, the fiscal policy looks towards creating a positive impact on the depressed economy but the government has to be very careful while looking to implement it as it could also turn into inflationary conditions. This could happen when the supply of money is excess i.e. government has pumped more money than required. This will result in more money chasing fewer goods which will result in an increase in the prices of goods and services and will have an impact on the overall performance of the economy. The government thereby has to monitor the fiscal policy closely and has to look towards implementing it in such a manner that the business is able to witness maximum benefit from it. These fiscal policies also have an impact on the budget of the government. This is as follows Reducing the tax rate would mean that the government will be able to collect less revenue as taxation is a source of revenue for the government. This will have an effect on the future planning as the government based on their estimated income through taxes has developed policies and different directions on which the money will be spent. Reducing the tax rate will have an impact on the earning which will thereby impact the budget. In addition to it when the government looks towards increased public spending the pressure on the budget increases as the government is unable to get sufficient revenue from the source of taxes and instead is looking towards extra expenditure on public spending. This will put additional pressure on the budget and also might make the budget turn negative which means that the government will have to use their reserves to fund the additional cost that is associated with the use of fiscal policies (Docters, Schefers, Korman & Durman, 2008). 3. The fiscal policies that have been implemented by the Australian government will help to bring major changes in different macro economic determinants which will help to bring changes in the manner the economy is performing. Fiscal reforms that are in place will result in major ramifications as due to the fiscal reforms the inflation rate for Q3 is up by 2% in comparison to 1.2% in Q2 for 2012 (Economic Note, 2012). This might make the fiscal reforms look ineffective and might highlight a case where the increase is primarily due to the fact that there is more money in the system. A look at the different determinants highlights that the increase in inflation has been due to carbon pricing which has been introduced on July 1 2012. Despite the inflation growth witnessed and fuelled by increase in fiscal policy is not a worry for the government due to bright prospects that the picture forecast for the growth of the economy. The growth of the economy remains positive and is primarily due to the fact that the domestic economy on the basis of expansionary fiscal policy has been able to show increased opportunity of growth as shown below (Fiscal Policy, 2012) The above diagram shows that the fiscal policy implemented by the Australian government has increased the money supply which had in turn increased the demand for goods and services which has resulted in the movement of the aggregate demand curve from AD1 to AD2. This has affected the overall employment level and has made the domestic industry to increase production which has thereby increased the level of employment and supply due to increased manufacturing of products as well. This is seen by the shift in the supply curve. The overall effect has thereby been very positive and has resulted in a change in the price and quantity at which equilibrium can be achieved (Commonwealth of Australia, 2012). This is something which the Australian economy has been able to achieve in the short run as over a longer period of time all the factors of production will become variable which will thereby have an impact on the supply. The situation has thereby given rise to some degree of inflation as the inflation rate for Q3 is up by 2% in comparison to 1.2% in Q2 for 2012. The situation is still under control and the monitoring by the RBA and the government will ensure that the economy is able to present a situation where the economic reforms help them to improve their growth in the economy. The Australian economy also has ensured that their expansionary policies are developed based on the following (BCA, 2012) This has helped the government to look into different factors like counter cyclical effectiveness, intergenerational equity and the size of the government. Using the above factors have ensured that the government is able to work on the different aspect through which the fiscal policies will be managed and have ensured that the policies help them to make decisions which helps the economy to grow (Parkinson, 2012). The overall fiscal policy developed by the Australian government thereby depicts that the performance of the economy should be sound and would be based on parameters through which overall efficiency in achieved and the economy is able to control inflation at the same time ensure increased consumer spending and better employment opportunities which will thereby help the economy to grow 4. In situation when the fiscal policies doesn’t fetch the rewards for which it has been implemented then the government has to look towards developing ways to increase the effectiveness of their policy. One such step which will help to ensure that the fiscal policy fetches the required return is to ensure that monetary policies are used along with fiscal policies. This will ensure an increase role from the Reserve bank and will help to ensure that the fiscal measures are directed in the right way. The major problem which is witnessed when the fiscal policy doesn’t work is that it gives rise to inflation. This could happen when the supply of money is excess i.e. government has pumped more money than required. This will result in more money chasing fewer goods which will result in an increase in the prices of goods and services and will have an impact on the overall performance of the economy (Garg, 2010). The government thereby has to ensure that the fiscal policies is used in a measured way and is monitored continuously. Also ensuring that the fiscal policy is used along with the monetary policy helps to reduce the impact of the fiscal policy on the economy. It ensures that the economy is able to use the benefit of both the monetary and fiscal policy so that they are able to garner maximum benefit and ensure that the economy is able to grow. The other problem which way incur when the fiscal policy doesn’t work in the desired way is that it has an adverse effect on the budget of the government. It might create a situation where the economy is able not get the benefit of fiscal policy and might result in creating a situation where the pressure on the budget increases (Garg, 2010). This will thereby have an impact on the overall performance of the economy and requires that a mix of both monetary and fiscal policy is used so that the economy is able to gain effectiveness and the economy is able to grow at the determined rate which will ensure better opportunities of growth and fetch the required reward that the fiscal policy should. References Business Cycle. 2012. The Business Cycle, Aggregate Demand & Aggregate Supply. Retrieved on October 27, 2012 from http://www.colorado.edu/Economics/courses/econ2020/section7/section7-main.html BCA. 2012. BCA Budget Submission 2012-13. Business Council of Australia Commonwealth of Australia. 2012. Mid Year Economic & Fiscal Outlook. Retrieved on October 27, 2012 from http://www.budget.gov.au/2012-13/content/myefo/download/2012-13_MYEFO.pdf Colell, M., Winston, A., Michael, D. & Jerry, R. 1995. Microeconomic Theory. 3r Edition, New York, Oxford University Press, Pearson Education Docters, R., Schefers, B., Korman, T. & Durman, C. 2008. The neglected demand curve: how to build one and benefit. Journal of Business Strategy, Volume 25, issue 5, pp. 19-25 Economic Note. 2012. Australian Inflation Still Within Target – Monetary & Fiscal Policy Update. Retrieved on October 27, 2012 from http://www.firststateasia.com/uploadedFiles/CFSGAM/News/20121024_CPI%20Q3%202012%20and%20Policy%20update_Asia.pdf Fiscal Policy. 2012. Fiscal Policy. Retrieved on October 27, 2012 from http://www.cliffsnotes.com/study_guide/Fiscal-Policy.topicArticleId-9789,articleId-9749.html Garg, S. 2010. Microeconomics: Introductory. 7th edition, Dhanpat Rai Publication Parkinson, M. 2012. Australia’s Place in the new Global Economy. Retrieved on October 27, 2012 from http://www.treasury.gov.au/PublicationsAndMedia/Speeches/2012/Australias-place-in-the-new-global-economy Mayerhoefer, C. & Zuvekas, S. 2008. The shape of demand: what does it tell us about direct to consumer marketing. The B.E. Journal of Economic Analysis & Policy, Volume 18, Issue 2, pp. 4-8 Shepherd, G. 2006. Vertical & Horizontal Shifts in demand curve. The Econometric Society, Volume 4, No. 4, pp. 361-367 Read More