Fiscal policy simulation essay

Erehwon country and it’s economy in now in the recession period, that is why all the economic indicators show us a steady decline. The GDP grows rate – that is the main economic indicator showing the efficiency of the economy – is only 4%, that is very low level. The government searches for the way out of recession. One of the possible ways of influence the economy is fiscal policy, that means changes in government spending according to the Keynesian model.
Fiscal policy concept and it’s simulation
Fiscal policy is a set of financial measures to regulate the state government revenues and expenditures that are modified depending on such strategic objectives as crisis management, maintenance of high employment, or the fight against inflation.
The main objectives of fiscal policy are: fighting inflation and unemployment; stabilization and economic development; counter-cyclical management of the economy; stimulating economic growth; achievement of the foreign trade balance. (Sheffrin 2003)
Depending on the situation in the economy are two main areas of fiscal policy:
– Stimulating fiscal policy;
– Contractionary fiscal policy.
During the recession the Erehwon’s government must conduct a stimulating fiscal policy. Erehwon’s economy is in a declining phase with concomitant cyclical unemployment of 6,32%. What in these circumstances the government should take? It has three main features of fiscal policy: 1) increased government spending, 2) tax cuts, and 3) a combination of the first two options. If the federal budget is balanced, the fiscal policy in a downturn should be directed to the creation of the budget deficit, that is, the excess of government spending over tax revenues.
The fiscal policy conducted by Erehwon’s government was stimulating, and included:
– decrease in government spending on infrastructure and education by 600$ million each;
– decrease in the income tax rate by 3,5%, that resulted in decrease in income tax revenues by 700$ million;
– the budget deficit was reduced to 2,7% of the GDP.
In other words, fiscal policy moved in the direction of the federal budget deficit during a recession.
We can see that government used changes in tax revenues. It is a good way to stimulate business because the amount of taxes depends on the incomes and businesses, and during the recession of production revenues starts to fall, which would automatically reduce the tax revenues to the treasury, and consequently, it will increase revenues which remain among the population and enterprises. This will to some extent slow the decline of aggregate demand, which has a positive impact on economic development.
It is necessary also to consider the multiplier effect of a balanced budget, that shows that equal changes in government spending and taxes cause an increase of the equilibrium value of GDP on their growth. For example, an increase in G and T on $ 100 million leads to an increase in GDP on $ 100 million at the same time, even though changes in government spending have a greater impact on total costs than the changes of the taxes. Balanced budget multiplier is a unity: the same increase in taxes and government spending will increase in GDP by an amount equal to increase in government expenditure and taxes. (Sheffrin 2003)
So the main economic indicators that are used for making decisions about fiscal policy are the GDP and the rate of its growth, levels of government revenues and expenditures; rate of inflation and rate of unemployment. When studying carefully all these economic indicators it is possible to make conclusions about the state of the economy in the country.