Running Head: FISCAL POLICY AND ECONOMIC ANALYSIS 1

FISCAL POLICY AND ECONOMIC ANALYSIS

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FISCAL POLICY AND ECONOMIC ANALYSIS

Fiscal policy and Economic Analysis

Introduction
Employment of taxation and spending by the government to influence the economy is
known as fiscal policy. The policy is used by governments to regulate the amount of aggregate
demand in the economy in order to fulfill the economic goals of stability of price, employment,
and growth in the economy. When it relates to fiscal policy, the government has two levers at its
discretion: Government can choose to change the amount and composition of taxation and/or
changing the amount of expenditure in various sectors of the economy. Classifications of fiscal
policy: Economy at equilibrium, policy of neutrality is normally used. Expansionary policy is
executed during recessions to stimulate economic activity. Government employs more money
than it gets in levies in such a scenario. Contractionary policy is used to pay government debt
and control the inflation. In such a scenario government expenditure is less than tax collection.
Analysis models
In the time of recession, Economists argues that lowering taxes rates and boosting
government spending is the most appropriate strategy to increase aggregate demand. In principle,
the ensuing deficit would be offset by a growing economy during the subsequent boom.
Recession period, expansionary fiscal policy is used to help recover the economy. It leads to
increased aggregate demand, which raises employment and output in the economy. Government
pursues expansionary policy by increasing spending, decreasing taxation, or a combination of the
two. Al-Rubay (2021) ascertained that tax reduction will result in more income disposal, more
consumption and savings, and move to the right of the aggregate demand curve. This policy will
result in a budget deficit if government spending surpasses tax income.
In case of demand-pull inflation, contractionary fiscal policy is enacted. The policy can be used
to pay down liability. Government can pursue this policy by reducing expenditures, rising taxes,
or a combination of the two. Contractionary policy moves the AD curve to the left. This sort of
approach will lead in a budget surplus if levy receipts surpass government expenses. Greater
government spending leads to increased aggregate demand, which raises real GDP, causing
prices to rise. This is referred to as expansionary fiscal policy
Levers of fiscal policy
The two levers available to the government for determining fiscal policy are spending
and taxes. Expansionary fiscal policy involves the government increasing expenditure, cutting
taxes, or doing both. Increased spending and tax cuts will raise aggregate demand, but the
magnitude of the rise will be determined by the expenditure and tax multipliers. The government
expenditure multiplier is a figure that reflects how much of a change in expenditure would result
in a change in aggregate demand. The tax multiplier is the magnifying impact of a tax adjustment
on aggregate demand. A tax cut has the same effect on income and consumption as an increase in
government expenditures.
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Justification of Fiscal policy

According to economic theory, budgetary tightening lowers inflation. Although a healthy
economy requires some inflation because a rising population need more money, too much
inflation causes prices to rise so quickly that businesses are unable to effectively prepare for the
future. Entrepreneurs may build their businesses at times of tight budgets. Small firms, for
example, fill the hole left by the public sector when it exits an industry (Asandului& Lupu 2021).
Companies can also utilize this opportunity to work on client retention and reducing wasteful
expenditure in their own budgets. For example, a coffee shop may provide a discount to
consumers who purchase a sandwich with their beverage and leverage greater sales from vendors
to obtain a cheaper price on supplies.
Aggregate demand and Aggregate supply
Supply Aggregate is the total amount of products and services the enterprises in an
economy are anticipating to sell at a given price. Aggregate demand refers to the total amount of
items and services that will be purchased at all potential price levels Caballero & Simsek
(2021).X-axis of a basic AS-AD model is (Y)is the output, and y-axis. (P) is-price. Determining
the equilibrium, supply aggregate and demand aggregate are used together in a graph. The point
at which demand and supply meet determines the manufacturing/production of an item or service
is referred to as the equilibrium. Demand and supply can change due to a variety of reasons, that
can alter production levels (Al-Rubay2021. There are discernible changes in production
variations between the short and long runs. An external move in the supply curve aggregate
would lead to more output and prices reduction in the near run. Change in the demand curve
aggregate to the right would boost outcome and raise prices. The manufacturing level changes as
due to short-run nominal volatility. In the near run, a rise in money causes an increase in output
owing to a change in supply aggregate. Increased number of items are created as the productivity
increases, and more items are purchased as prices fall.
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Figure 1 Aggregate demand and supply curve

Theories.
Classical theory was amongst the early modern school of thinking in economics. Year
1776 was when it began and lasted until roughly 1870, when neoclassical economics emerged.
Thomas Malthus, Adam Smith, David Ricardo, John Stuart and Mill Jean-Baptiste Say are
examples of notable classical economists. Society was undergoing significant changes during the
time when classical thought originated. The central economic challenge concerned the way a
society would be planned around a system in which each different pursued his or her personal
financial benefit (Singh,2021). Economic assumptions of classical theory Markets that self-
regulate: Classical thinkers thought that free markets self-regulate when there is no interference.
According to (Li & Li ,2021), classical Theory of Linear Multistep Methods for Volterra
Functional Differential Equations. Discrete Dynamics in Nature and Society, 2021.Since markets
gravitate to their natural equilibrium without external interference, Adam Smith referred to
market's as a capability to regulate themselves as the "invisible hand." According to classical
theory, elastic interest duties will always reserve equilibrium. According to classical theorists,
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FISCAL POLICY AND ECONOMIC ANALYSIS

real GDP may be estimated without having the knowledge of the currency supply or the inflation
percentage.
The Keynesian theory was developed in economics by British economist Maynard John
Keynes in his book published in 1936.The Theory of Money, Employment, and Interest which
was released during a Boundless Misery. According to Keynesian economics, aggregate demand
has important impression on economic production in the short run, particularly during
downturns. According to Offe (2021), regarding to theory of Keynesian, aggregate demand does
not always match the economy's full potential. According to Keynesian thinkers, aggregate
demand is impacted by numeral of issues which responds unpredictably. Keynesian theory is
distinguished by the following beliefs: Unemployment is caused by fundamental flaws in the
economic system. Recession period, the economy may not be able to get back to its normal on its
own. One of the most important economic problems, according to Keynesian economists, was
aggregate demand of properties and services did not meet supply issues. Excessive saving, or
saving for the sake of saving rather than investing, is a severe issue that has fueled recession and
even despair (Robinson, 2021). Wage cuts cannot solve a recession. Coming out of an economic
downturn needs simulation of the economy, which might be accomplished by lowering interest
charges and boosting government investment.
Inconclusion to the article, Advocates of stabilization programs believe that prices are
sufficiently sticky that the economy's natural adjustment to its potential will be a protracted and
painful process. Unacceptably high levels of unemployment will continue for all too long in an
economy suffering from a recessionary void. Increased prices that emerge when the short-term
aggregate supply curve swings higher impose an excessively high inflation rate in the near term
for an economy with an inflationary gap. The economist’s argument is that by use of stabilization
policy to adjust the aggregate demand curve in order to decrease the duration the economy is
vulnerable to a gap is considered be better. Therefore, through the application of the mentioned
models the Malaysian government can be able to deal with the issue of inflation accordingly.
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Appendix

Figure 2 Aggregate demand and aggregate supply curve model

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References
Caballero, R. J., & Simsek, A. (2021). A model of endogenous risk intolerance and LSAPs:
Asset prices and aggregate demand in a “Covid-19” shock. The Review of Financial
Studies.
Al-Rubay, R. K. (2021). The Economic and Social Implications of Unemployment on The Aggregate
Demand and The Labor Market In Iraq. Turkish Journal of Computer and Mathematics Education
(TURCOMAT), 12(10), 3389-3402.

Asandului, M., Lupu, D., Maha, L. G., & Viorică, D. (2021). The asymmetric effects of fiscal policy on
inflation and economic activity in post-communist European countries. Post-Communist
Economies, 1-21.

Offe, C. (2021). Competitive party democracy and the Keynesian welfare state: Factors of stability and
disorganization. In The political economy (pp. 349-367). Routledge.

Robinson, J. (2021). Economic philosophy. Routledge.

Singh, P. (2021). Classical Theory of Imperialism and Contemporary Capitalism. Journal of

Contemporary Asia, 1-25.