What Is Fiscal Policy - Essay Example

Literature and theory report Affiliation Fiscal policy involves the way the government collect government revenue and spends tomake an influence on the economy. Fiscal policy stipulate how much government expenditures are to be shared among the different sectors in the economy. In this report, I have considered three articles and their argument on this topic. In his article, Furth (2014) put forward a discussion on fiscal policy in the great recession and Europe borrowing crisis.1 His article seeks answers to the questions on stimulus and austerity. He notes that the recession sparked debate among economists with one school of thought arguing that the government expenditure is a problem to the economy while the other thinking is that it is a solution to economic betterment. Further notes that European Union has not adopted strict approach of fiscal obligation, taxation reduction and economic freedom.2 Furth is concerned with data on deficits, expenditure, taxation and growth in relation to the fiscal policy stand of thirty-seven European countries. His research revealed that structural deficits would predict stimulus followed by reduction on deficit, and he documented a variability of fiscal policies that many economies have pursued in paradox to a number of prevalent generalizations of European austerity.3 He notes that increasing taxes would be far more harmful than expenditure cuts,4 and the effect of tax increment have a huge difference, and they cannot be together labelled as austerity as they would conceal more than there is in the revelation of fiscal policy.5 Furth research has shown the relationship that exists between increased government expenditure and economic progress. Other economists had focused on government debt and its effect to the economy. It had been noted that government debt hurt the economy by burdening not only the current generation but also the future generation.6 Due to high debt the current generation is forced to pay for the interest of the loan advanced to the country for which benefit will be consumed by future generation. Moreover, the future generation will carry on the burden and mistake of their predecessors because the rate of interest will be much higher that the benefit of which it was taken. Furth’s research presents another angle to fiscal policy approach that the government can utilize without resulting to changing the taxation system. It reveals that there has been a considerate role of the government inability to set up good fiscal policies. Governments have concerned themselves in increasing taxes in order to be able to manage its debts, and this hurts the economy badly. High taxes means that the cost of living rises with the high taxes being transferred to citizens through high prices of commodities and services.7 Other economists had focused on the effects of the government debt on the economy while this article provides supporting evidence of the policies adopted by the government in fiscal policy as other determiners of economic progress. As government debt seeks to increase the burden to present and future generations, fiscal policy adoption would contribute to more saving that can be used in infrastructure and another capital investment. My research puts forward the need to focus on tax reduction as well as keeping government spending low. Alesina and Rugy, argued that economists have agreed on a general basis that fiscal adjustments of spending would not only reduce the debt-to-GDP ratio than adjustments on tax but also are less likely to start a recession.8 Supporting this argument are The Heritage Foundation whom on October 2013 showed that tax-based consolidations would be three to four times less on consumption and GDP compared to spending-based fiscal consolidation.9 Furth greatly believes that the adoption of a better fiscal policy would be so important in the management of the economy.10 He argues that higher taxation would not be beneficial in tackling the national debt but sees a need to cut on government spending and reduction in taxes. Moreover, Furth sees it rational to focus on stimulus rather than austerity, and the best way to make sure stimulus thrives is by adopting fiscal policy in good economic times. He argues that tax reduction should be taken into account far more than government expenditure cut. However, both fiscal policies and austerity measures are useful in economic progress. Furthermore, Furth agrees that a reduction in government expenditure alone cannot steer economic growth, but coupled with a tax cut the economy of firms and household would increase as a result of increased consumption ad production. Furth provides an analysis of the recession and Europe debt crisis to explain his views.11 He notes that fiscal prudence and reforms would be important when taken in good times. The prove that those countries that had lower borrowing costs and budgets closer to balance were able to enact systematically larger plans between 2008 and 2009.12 Reforms made by Sweden in the 1990s are exemplary on how prudent reforms can allow fiscal flexibility in a crisis.13 They were able to lower taxes and pension reforms took off pressure on the country’s long-term finances, and still their currency was independent of the euro in the wake of the crisis. On the other hand, there were raised income taxes, and pensions grew rapidly in Portugal.14 In 2005, before the financial crisis, its economy was weak and grew slowly. Furth has made several assumptions in his report. He has based his arguments on government fiscal policies in economic progress while considering import and export as constant variables. For example, he based his assumptions in the light of the recession, economic debt crisis and evaluates the nations that were able to pull through the hard economic times. The analysis is then based on their policy adoption and those that suffered greatly and related them to fiscal policies they were using.15 Based on those assumptions, he was able to conclude that countries that had considered lower taxes and government expenditure cuts in the Euro-zone were able to recover soon than others such as Portugal. In his research paper, Adam ventures into how fiscal policies affect government debt.16 He asks two important questions regarding government debt in relation to fiscal policies. He asks on how the government debt would affect the optimal conduct of monetary and fiscal policies. Secondly, their implication for the evolution of government debt over time. He concurs that high government debt levels would make it optimal to reduce public spending, so as to reduce the harmful incentive effects of distortionary taxes and more importantly influence optimal stabilization following technological advances. He notes that higher debt levels would lead to larger risks to tax rates and fiscal budgets. Based on notes it would be important to reduce government debt over time. Government debt has shown important consequences for realizing optimal fiscal and monetary policy.17 With increased national debt, it would be required that we lower the average public spending level and also lead to increased risk of fiscal budgets due to tax base fluctuations.18 The risks can lead to important incentives seeking to reduce government debt over time. However, according to Knot, optimal debt dynamics does not necessarily follow random walk behavior.19 His research shows that the debt would reduce to zero over time if government adjust to spending plans that are consistence with the rise or fall of the tax base. His research does not fully consider the optimal speed of debt reduction. Global inequality constraints like the borrowing limit implied by the Laffer curve may have incentives for debt reduction.20 The research article had also considered technological shocks. In addition, there could be others such as the shocks of agents that could also lead to additional sources of budget risk. In Colligan article, he approaches fiscal policy and government debt in the light of interpretation based on the interaction to the environment and not as a statistical concept.21 He argues that if debt has to increase over time, policy makers have a responsibility of responding to the changing conditions in economic growth and to the cost of interest rates. Debt ceiling legislation plays an important role to avoid debt increases in the country. The empirical evidence that he provides shows that the public debt in Europe is sustainable when practicing temporal budget constraints. He recounts that complying with the temporal budget constraints is not sufficient. Government need to raise revenue to be able to pay for its debts. The problem makes the country invulnerable to pay for the debt, and more so make the economy illiquid when it cannot access financial markets at reasonable terms when old debts come into maturity. Greek fell into a liquidity crisis in 2010. The lack of fund by the government prompted the EU to bail out its debt for it to recover from the crisis. The crisis can turn into a solvency crisis when high rates premium lead to increasing in interest rates. My research focuses on how fiscal policies and government relate. It has been notable that the policies adopted can either seek to reduce government debt while still maintaining a faster economic progress or lead to slow growth of GDP. Unbalanced budget put burden to the future generation and reduce consumption to the current generation. In this way, the citizens are unable to save and invest as much of their income goes to repaying government debt. The inability to save and invest lead to lack on income from capital investment and make the costs of doing business to rise. Following reduced capital, the rate of returns reduces prompting an increase in interest rates. This is evident in developing countries where there are no infrastructure making it impossible to transport people and goods. A higher interest rate would make foreign investors invest in the U.S implying larger trade deficits since increased investment would be followed by increase in trade deficit. The variables that are important in this research is the monetary variables and public sector variables. Monetary variables such as money supply, nominal interest rate, nominal investment and nominal consumption define economic zone and thereby much important when formulating fiscal policies. Monetary variables are either known to be expansionary or contractionary. Exapasionary variables are used to increase the amount of money in circulation in an economy. The government considers some policies like reducing the interest rates to reduce unemployment or recession. Contractionary variables on the other hand are done to reduce the amount of money in an economy. Policies such as increasing interest rates are employed in order to reduce inflation. During the contraction and the expansion processes, the amount lend to the public is independent of the rate of interest charged. On the other hand, real variables such as employment, real production and real economic growth dictate on expenditure and the regulation of government spending would call for evaluation of their performance. Fiscal policy, therefore put forward on government cuts in spending and reduction of taxes relates to fiscal policy and government debt reduction. Furths research paper echoes this. Finally, the theoretical model of income as a dependent variable of investment, consumption, government spending and as well as import and export reveals how government debt is a burden to future. Moreover, it explains ways in which the government can engage to provide better economic growth to avoid a recession.22 The three articles I have considered have considerably provided evidence on how fiscal policies have affected national debt and continue to do so in the modern times. Bibliography Adam, Klaus. 2010. "Government Debt and Optimal Monetary and Fiscal Policy." Mannheim University and CEPR 2-29. Alesina, Alberto, and Veronique de Rugy. 2014. A Review of the Scholarship on Austerity. Economics, London: June. Colligan, Stefan. 2012. "Fiscal Policy Rules and the Sustainability of Public Debt in Europe." Sustainability of Debt 3-29. Furth, Salim. 2014. "Stimulus or Austerity?" Fiscal policy in the Great Recession and European Debt Crisis (Heritage Foundation) 40-63. Knot, Klaas. 1996. Fiscal Policy and Interest Rates in the European Union. Edward Elgar Publishing: London. Read More