Afonso & Sousa (2012), in their article ‘The Macroeconomic Effects of Fiscal Policy’ seek to prove that fiscal policy is a useful instrument for the regulation of aggregate demand’s level and stabilizing business cycles. The policy’s effect on economic activities has not received much acknowledgment compared to monetary policy’s effect on the economy. The authors investigate the macroeconomic implications of the policy in some countries by first considering the impacts of the policy on the composition of the Gross Domestic Product (GDP). Secondly, they ask how fiscal policy shocks affect the asset markets. After identifying the policy shocks, the authors estimate a Bayesian Structural Vector Autoregression model for the study; feedback from the government debt is included in the estimations. The authors apply the use of quarterly fiscal data to obtain more accurate effects of the fiscal policies.
Fiscal policy refers to a situation where a government adjusts its spending levels and tax rates to monitor and control a nation’s economy. This policy is majorly concerned with balancing government equations and taxation. It can either be used to stimulate a slow economy for instance, by reducing tax rates, which will increase spending among people or to slow down an economy growing too fast, for example, by raising the tax rates. Fiscal policy is described as tight or contractionary if the revenue is higher than spending and is defined as loose or expansionary when spending is greater than income.
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The authors organize the article, with regards to the estimation study, in the following manner. The first section of the article contains the introduction of the effects of fiscal policy research; the second part entails a review of the related literature which they use in the study; strategies used to identify the consequences of the policy comes in the third part. The fourth section of the article provides results and analysis, and finally, the conclusions about the policy implications are in part five.
The results of the estimation study point out towards an expansionary consequence of fiscal policy in the case of some areas such as US and UK; and ‘Non-Keynesian’ multiplier in Italy and Germany. Expansionary fiscal policy refers to the situation where the government decreases tax rates and increases government expenditures. Responses on the asset markets suggest that stock prices negatively react to a rise in government spending hence a deterioration in public finances. When government feedback is taken into account, interest rates and GDP become more insistent and more responsive to the shock. A more detailed financial and economic implications of the policy according to the study is as explained below.
The most immediate implication of fiscal policy is the cause of change in the aggregate demand for goods and services. For instance, a fiscal expansion raises aggregate demand through one of two means. For starters, in a situation where the government increases its purchases but keeps tax rates constant, it increases demand directly. Secondly, if the government increases transfer payments or reduces tax rates the disposable income in households’ rises, more is spent on consumption. The increase in consumption, in turn, results in an increase in the aggregate demand.
Besides affecting aggregate demand, fiscal policy impacts on the economy by changing incentives. Imposing taxes on certain activities have a tendency of discouraging those activities; high tax rates reduces people’s motivation to earn income. By reducing either the level of taxation or even the marginal tax rates, the government can increase output from the public. A study shows that reductions in rates of tax have a significant effect on the amount of labor supplied and thus, an effect on output.
Fiscal policy also influences the burden of future taxes. Whenever the government operates on expansionary policy, it acquires debts which are due to be paid in the subsequent years; this policy imposes an extra burden on taxpayers in the future. Certain economists have reasoned that this effect of fiscal policy on future taxes will lead to consumers to change their saving. By gaining awareness of the idea that current tax cuts only means higher taxes in the future, people will simply save the value of the tax cut they currently receive so as to pay those future taxes. Practicing the ‘saving’ strategy will result in an economy where tax cuts have no impact on national saving since modifications in private saving will precisely counterbalance changes in government saving.
The fiscal policies also have an effect on the composition of the aggregate demand. Increased government borrowing may lead to a reduction in the size of the private sector. In a situation where the government runs out of deficit, it issues bonds in a bid to meet some of its expenses; which results in it competing with other private borrowers for finances. When other factors are kept constant, a fiscal expansion will lead to raised interest rates, and ‘crowd out’ of some of the private investment, which will ultimately reduce the portion of output made up of the private sector.
In an open economy, fiscal policy also has impacts on the exchange rate and the trade balance. In the scenario of a fiscal expansion, government borrowing results in increased interest rates which attract foreign investment. In their attempt to get funds for investing, the potential foreign investors bid up the value of the currency which causes an exchange-rate appreciation. As a result of this appreciation, imported goods become cheaper within the country and exports more expensive outside the country, resulting in a decline of the merchandise trade balance. However, accumulation of debts by a government can also cause a distrust of the country by foreigners, which can cause a depreciation of the exchange rate.
The fiscal policy can affect the financial and economic statuses of Excel Connection in that it affects the aggregate demand through changes in government spending and taxation rates. Aggregate demand refers to the total demand for goods and services in a company. Government spending and tax rates affect household income which dictates customer’s spending. Consumer expenditure can affect the company’s employment rates and policies, business expansion, and net exports. Fiscal policy can also affect Excel Connection’s cost of debt and the relative rate of consumption versus saving.
The fiscal policy applies to the wire harness and cable assembly industry (Excel Connection), in a variety of ways. The company can adjust its spending levels and sell prices to monitor and control the economy of the business. Being a company that offers many services, the managers can monitor the goods and services on higher demand and those that customers rarely purchase, and adjust prices accordingly, so as to maximize profit, and the same time, ensure all the products are equally purchased. This strategy can be achieved by say reducing the costs of the less purchased goods and services, so as to entice more buyers/customers while at the same time increasing the prices of the highly purchased.
The policy not only ensures more revenue for the firm, but it also curbs the loss the business acquires from selling the less popular services at a throw-away price. By carefully applying the fiscal policy in controlling one’s business, my company (excel connection) will be able to embrace and utilize all the disadvantages that result from the policy, while keeping off the negative consequences of the policy that is a risk to the financial and economic stability of any given business.
Reference
Afonso, A., & Sousa, R. M. (2012). The Macroeconomic Effects of Fiscal Policy. Applied Economics , 4439-4454. doi:10.1080/00036846.2011.591732
