The Governments Fiscal Policy - Essay Example

”The government’s fiscal policy is its plan for spending and taxation, it is designed to steer aggregate demand in some desired direction” (Baumol and Blinder 600). The fiscal and monetary policy is important because it determines the amount of intervention or lack thereof by the government in stimulating the economy. The ‘invisible hand’ as proposed by the great economist Adam Smith and to whom the classical view is attributed, suggests that the economy is able to repair itself without a need for a change in policies such as government spending or including tax reductions. Economic problems such as recession naturally happen subject to correction by the economy itself.
Keynes, on the other hand, argued for a more reactive response from the government because without it unemployment will only extend. To battle this, government intervention is necessary because fiscal policies can stimulate the economy. The state cannot wait for the self-correction of prices and wages. Developed during the Great Depression, this theory assumes that prolonged unemployment will only hurt the economy.
This now could lead to a ‘crowding out’ because of higher interest rates which reduce investment and consumer expenditures that are affected by it. This diminishes the merits of the fiscal policy as implemented by the government (Cliffnotes n.p.). Read More