Fiscal Policy and US Federal Economy in 2010-11

Discuss what is meant by Fiscal Policy

Fiscal policies are the government spending decisions that affect the entire economy (Perry, 2008). These policies include taxation, government spending, and government borrowing. They directly influence the level of economic growth, employment, and output in the economy. The government, through legislation, can choose to apply either expansionary or contractionary policies. How well the government controls fiscal policies determines how fast or slowly the economy of a country grows. Sound fiscal policies enhance cost-effective spending and development.

What are the instruments of fiscal policy? Evaluate the effectiveness of increasing government spending and tax cuts as a means of stimulating aggregate demand.

The government, in its attempt to influence the economic performance of a country, uses fiscal policy instruments. The main instruments at the government’s disposal are taxation and spending (Baumol & Blinder, 1994). However, the government may also use transfer payment as an instrument of fiscal policy.

There would never be a better income-generating activity than taxation to the government. The most common method of taxation is direct taxation of income earners. Personal taxes, value-added tax, and revenues levied on licenses and permits for different reasons are among the common forms of taxation. Taxation ranks among the most important fiscal tools in an economy. Taxation is a weapon the government can use to save a dwindling economy from collapsing. The introduction of tax cuts can help stimulate aggregate demand. Reducing taxes works like a two-edged sword. First, it stimulates an increase in disposable income.

When taxes are reduced, the money which would have otherwise been used for paying taxes is available for consumption to households. This increases their purchasing power hence, increase in demand. On the other hand, lowering business taxes increases their profit margin, this leads to increased production. Increased production leads to an increase in demand for raw materials and laborers. The result is more employment opportunities for citizens.

People employed in the firms earn money which increases the level of income available in an economy to spend. Expenditure is another weapon the government may use to stimulate aggregate demand. By increasing expenditure, the government aids economic development on many fronts. For instance, investing in infrastructure development requires skilled and casual laborers to complete the projects. This creates direct employment opportunities for the people involved in construction work and other indirect opportunities for those supplying services and logistics to the building process.

The people employed in the process, either directly or indirectly, earn wages and salaries, which increases their ability to purchase goods, hence an increase in aggregated demand (Krug, 2011). The government may also increase spending on education to increase knowledge and skills among its citizens (Russell & Heathfield, 1999). This increases the chances of employment for the citizens. The importance of this cannot be ignored.

Increasing government spending and lowering taxes is proven beyond measure to be necessary tools in stimulating aggregate demand. It is, therefore, the mandate of all policymakers to wisely use the power vested in them by the state to maintain a stable economy. Stability hinges on the kind of macroeconomic policies made.

Explain, using the statistics of government expenditure, personal taxation rates, and transfer payments, what fiscal policy stance did the 2011-12 Federal Budget take?

The 2011/2012 budget saw many significant cuts. This is an indication that the government is using fiscal policies as a means of stimulating growth. Dependent spouse tax is one of the budgetary components that were significantly affected. This tax was completely phased out, perhaps to stimulate aggregate demand. This will save the government $755 million (Australian budget services, 2011). An additional $1.1 is expected to be saved from raising public sector dividends and a further $470 will be saved by scrapping off low-income tax offset. Small and medium-sized businesses have also been provided will cuts. Any business that has a turnover of $2 million and below, gets write-offs on any motor purchases.

The government’s transfer payment policy has also experienced cuts. The transfer payments are payments made by the government and have no productive return. Transfer payments Include unemployment benefits, social security funds to the elderly, and payments made to the poor. By reducing the amount of money spent on such payments the government has reduced the amount of disposable income to the individuals involved.

Evaluate the appropriateness of the government’s fiscal policy stance to the present economic situation within Australia with particular reference to the growth rate, level of inflation and unemployment, the current account deficit, and monetary policy stance

The government’s fiscal policy stance is appropriate in many ways. By phasing out the dependent spouse rebate, the government will push spouses under the age of 40 to go back to the job market. This will reduce the number of people out of jobs, the unemployed (Symes, 1995). As a result, the government will save approximately $ 2 billion. When many people get to employment, the economy grows.

Reducing government expenditure also reduces the level of inflation. This is because little money remains in circulation, which intern curbs inflation. The government’s current account deficit is also affected. The government’s cuts have provided extra cash, which has ensured that part of the budget deficit is met. Notably, the government did not provide any personal tax cuts. This will go a long way in controlling inflation.

Introducing infrastructure tax benefits is also justified and appropriate. By introducing the benefits, the government has opened the opportunity for private investors willing to invest in infrastructure development to proceed. This will ensure improved infrastructure, which will lead to increased business activities.


Australian budget services 2011, Federal Budget. Web.

Baumol, W.J.& Blinder,.A.S 1994, Economics: principles and policy, 6th Edn, Dryden Press, Fort Worth.

Krug, S 2011, Optimal Taxation in a Federal System of Governments, GRIN Verlag GmbH, München.

Perry, G.E 2008, Fiscal policy, stabilization, and growth: prudence or abstinence?, World Bank, Washington, DC.

Russell, M.& Heathfield, D.F 1999, Inflation and UK monetary policy, 3rd Edn., Heinemann, Oxford.

Symes, V 1995, Unemployment in Europe: problems and policies, Routledge, London.

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