In economics, fiscal policy refers to the means by which governments adjust their levels of spending so as to monitor and influence the countries economy. It is basically the policy with respect to government spending and revenue collection to influence the economy. It is contrasted to monetary policy through which the central banks influence nations’ money supply or macroeconomic policy that stabilizes the economy by controlling interest rates.
The two types of instruments in fiscal policy are automatic stabilizers and discretionary measures (Mushin, 2002:42). Automatic stabilizers operate automatically without government decisions, as circumstance merit, to decrease the fluctuations in the aggregate output level. Discretionary measures are deliberately introduced by the government on each occasion they are used. The boundary between the two is not clear, but in both categories, government expenditure and taxation are the main instruments of fiscal policy.
How to aggregate demand can be shifted using fiscal policy
The aggregate demand curve represents the combination of equilibrium aggregate expenditure and alternative price levels. Changes in government purchases and taxes shift the aggregate demand curve. A decrease in taxes or an increase in government spending raises the level of expenditures at each price level and shifts the aggregate demand curve to the right. The figure below shows the effect on aggregate demand.
The initial effect of the increase in government expenditure or a decrease in taxation shifts the aggregate demand curve from AD1 to AD2. However, the interest rate is the cost of borrowing and its increase attempts to reduce the quality of products demanded, especially for investment goods (Mankiw, 2008:555). This crowding offsets the effect of fiscal expansion on the aggregate demand curve shifting it to the AD3.
Fiscal policy stance assumed in the Australian Government’s Budget
The recent natural disasters had a significant impact on the Australian economy and the fiscal position of the government. As a result, the net debt is expected to peak at 7.2% of GDP in 2011/12 higher than previously anticipated. Over the financial year 2011-2012, the government is employing an expansionary fiscal stance with the aim of stimulating growth. This is being done through increased government expenditure and reduced taxation in an effort to increase consumption and investment.
Apart from climate change and energy efficiency, the government will increase its spending on other sectors. It will also be providing the states with financial assistance for specific purposes and revenue assistance. The government is determined to reduce taxation by introducing the Entrepreneurs tax offset, delaying the introduction of excise and excise-equivalent duty on alternative fuels, phase out the dependent spouse tax offset, and many other exemptions from tax (Australian Government, 2011:1).
Inflationary pressures witnessed in the Australian economy and the fiscal policy position of the government
The inflationary pressures being experienced in the Australian economy include; decreased GDP growth, high rates of unemployment, depreciation of the Australian dollar, global financial crisis, and fragilities in the international economy. The recent natural disasters such as the Japan tsunami and the rising oil prices are the major causes of the economic crisis. The country has employed an extensive expansionary fiscal stance to stabilize the economy.
The strategies in the fiscal stance are aimed at enhancing investments, empowering entrepreneurs, and sustaining public finances. Achieving these goals will ensure economic growth supported by the strong economic conditions in the region. This growth will drive substantial growth in jobs and hence reduce unemployment which will bring price and capacity pressures as well as the appreciation of the Australian dollar.
Australian Government, 2011 Budget Measures 2011-12. Web.
Mankiw, N., G. 2008 Essentials of Economics. Independence, KY: Cengage Learning.
Mushin, J. 2002 Output and the role of money. Fitchburg, USA: World Scientific.