Fiscal Policy and Its Implications
Fiscal policy refers to the deliberate government adjustment of taxation and spending to influence the country’s economic growth. Fiscal policy is significant in maintaining a low inflation, stabilizing the economic growth and stimulating the economy notably during the recession. Fiscal policy is mainly applied in aggregation with monetary policy since the two policies work dependently to stabilize the economy. There are two types of fiscal policy: expansionary and deflationary policy. Expansionary policy stimulates aggregate demand and enhances the economic growth rate. Expansionary policy entails lowering taxes, higher spending and also used in recession. Whilst deflationary fiscal policy minimizes the aggregate demand and inflationary pressures. In the UK, fiscal policy was highly appreciated as a microeconomic tool in the 1930s after UK long-term experience of deflation and low growth in 1920s (Bhattarai & Trzeciakiewicz, 2017). The policy was adopted to balance the budget since in the 1920s there was high unemployment rate and anemic growth in the UK.
The alteration of taxation and government spending as the main fiscal policy tools would ultimately determine the micro-economic activities that influence that rate of growth. Taxation includes capital gains from investments, sales and property, and income. Thru taxation the government obtains revenue for the annual budget allocation. However, the shortcoming of taxation is that the taxpayers have less to spend on their income generated. Alteration in taxes would affect the changes in consumption and consumer’s income which lead to change in the national GDP. The government can apply taxation to reduce the unemployment rate and stimulate the rate of economic growth in the process of cutting taxes. Tax cuts allow consumers to obtain more money which leads to increased revenue for their business. Similarly, government spending is concerned with subsidies, public projects, government salaries and remuneration, and transfer payments such as welfare programs. Thru this expenditure the government is able to cut the unemployment ratio and empower the development of private sector.
The fiscal policy tools are crucial in a European nation because the European Union uses the tools as indicators for determination of the health of the economies. Under the terms of EU, the member states were obliged to sustain their deficits and debt to certain limits (Nugent, 2017). The states are mandated not to surpass 3% and 60% of government deficit and debt of its GDP respectively. If the member states do not comply with the terms, the excessive deficit procedure is prompted. The deficit procedure may include the possibility of sanction so as to encourage rectification. As a result, the government deficit in the third quarter of 2017 recorded as a GDP of -0.3% compared to the second quarter which recorded a GDP of -0.1%. However, in 2008, the EU government recorded a GDP deficit of -7.0% due to the financial crisis. The UK deficit in 2016 was influenced by dividends from the central bank. Moreover, the UK debt was resulted due to the national currency which depreciated against the euro during the first three quarters of 2016 and later appreciated in the fourth quarter and the first quarter of 2017.
Alternatively, other terms of the EU require the member states to fund the organization excluding its revenue generation from import duties on products and services. The member states agree on the size of the budget and how to finance the union (McCormick, 2017). According to records, the EU attains 98% of its funding from its member states. The principle of the EU demands its expenditure to match its revenue funded. However, the union has built other schemes to aid and compensate some of the states which felt that they were highly funding the union compared to the other countries. The UK is compensated 66% of the difference between its funding and what it obtains from the budget. According to their budget, the total amount of resources to cover the yearly payment appropriations are not certified to surpass 1.20% of the gross national income of the EU. The union’s regulation demands the union to spend the funds in a transparent and accountable manner. Over 78% of the EU budget is managed incorporation with the national authorities thru a shared management process.
However, the EU has no fiscal policy either for the whole Union or the member states since the systems of government and administration differ. Similarly, the revenues of EU are not supposed to surpass 1.7% of its GDP and the expenditures are also limited. On the other hand, the revenues of the US government are 21% of the GDP which gives the US a substantial scope for its fiscal policy in diverse ways (Mbanga & Darrat, 2016). For instance, any changes in the federal government budget would ultimately stimulate the inclusive spending on goods and services. In addition, the US federal government has no constraints on the state budget as compared to the EU sanction policies on their budget. However, the states are only barred from running deficits by their own constitutions.
Adopting fiscal policy in a state helps to stabilize the economy and minimize fluctuations in areas like unemployment and inflation. Alternatively, fiscal policy will attempt to maximize the correlated level of national income. To use fiscal policy to stabilize the economy, the government has to tax less or spend more to escalate deficit and raise taxes while cutting the expenditure to decrease the deficit. Hence, to stabilize the budget and the economy the government has to balance the economic boom and recession. Furthermore, the economic stabilization policy does not recommend the government taxation and expenditure to be equivalent in the opposite sides of the business cycle so as to control the aggregate demand.
Bhattarai, K., & Trzeciakiewicz, D. (2017). Macroeconomic impacts of fiscal policy shocks in the UK: A DSGE analysis. Economic Modelling, 61, 321-338.
Mbanga, C. L., & Darrat, A. F. (2016). Fiscal policy and the US stock market. Review of Quantitative Finance and Accounting, 47(4), 987-1002.
McCormick, J. (2017). Understanding the European Union: a concise introduction. Palgrave.
Nugent, N. (2017). The government and politics of the European Union. Palgrave.