Ch 12: Fiscal Policy and the Business Cycle
Part 1: How government can affect aggregate demand through tax policy
The government has various fiscal tools it can use to increase the GDP. It may increase its spending by borrowing more because the taxes don’t change. If we hold all the other factors constant, then with more debts, the GDP would increase. Another tool is by making government spending as a constant, then lower the taxes. This move will see that the households and firms in the country have more money at their disposal. By the act of holding the spending constant, this means they will be reducing their revenues and will have to result in borrowing more debts to facilitate their spending.
When we hold government spending and lowering taxes, we are increasing the money in circulation. When people have more money they will spend more, this means the demand will increase. When the demand rises, the GDP will also increase as people are spending more. Therefore, we can say that fiscal policies are not entirely concerned with reducing or increasing government spending, but rather it can be based on the tax policy of a country. By tax policy of a country, i mean increasing or reducing taxes.
The government can use tax policies to increase the aggregate demand or decrease it based on the situation of the country. When a government reduces taxes, people will have more income at their disposal, and thus, they will increase their spending; conversely, when taxes are high, people will spend less as they try to minimize their spending.
Part 2: Effectiveness of fiscal policy
According to Keynes, boosting the aggregate demand was the place to go as it would increase the economy. He further states that savings will never bring about growth. He says that the government should reduce taxes and increase the money in the hands of the households and the firms. This move would boost the economy as aggregate demand would increase, creating a boom in the economy.
Hayek, on the other hand, had an idea that Keyes’s view was wrong as he states that Hayek failed to indicate that if the taxes were lowered for a long time, then the economy would create a bust, and the GDP would decrease. He says that malinvestments would destroy the economy; he views that capital was vital. He states that the government should not lower the taxes but rather increase investments.
My perspective on how to make these fiscal policies work better is by reducing taxes and increasing the aggregate demand. The government should regulate the incomes of the people and ensure there isn’t too much money circulating as this would cause there to be a depression in our economy. The two perspectives by Hayek and Keynes are all good, but they should be incorporated to work as one as we have one economy, so it’s upon us to unite and ensure we save the economy.
The government may increase employment rates to increase the demand for products and services. Entrepreneurs should also be financed to ensure they stat new businesses, which will then increase the employment opportunities and therefore increase demand in the long run. The government can do a lot to ensure the economy is stable. It can regulate the fiscal policies to ensure they fit with the current economic situation in the country. In my view, both Hayek and Keynes were right in their claims as if we depend on lowering taxes now, and then our economy may come crashing down.