To What Extent Does Contractionary Policy Contribute To A Decline In Economic Activity?

1600 words - 6 pages

Fiscal policy is the government’s attempt to influence the economy by setting and changing taxes, government spending, and the government’s deficit and debt (Matthews et al 2003). Contractionary fiscal policy is, therefore, a policy where a decrease in government’s spending, an increase in taxes plus a decrease in transfer payments are applied to mitigate the inflationary issues that occur during a business cycle expansion. Thus, it restrains the economy, decreases the inflation rate and closes the inflation gap. This Essay will investigate the extent of the contribution of this policy to a decline in economic activity. Consequently, it will analyse the effects on economic activity under the Keynesian theory, the “classical” theory, and the Mundell-Fleming model. Furthermore, commentary on the results of an empirical study under a fixed exchange rate regime of the Obstfeld and Rogoff model will be provided and contrasted to other theories and models.
Contractionary fiscal policy, which is a reduction in the budget deficit, works through government spending and taxes. However, it is easier to separate them into three tools, namely, government purchases, taxes and transfer payments to see their effect on economic activity in the short run, medium run and long run. Government purchases are government expenditures, which are undertaken by government agencies, on final goods and services or gross domestic product in an economy. These include small items such as paper clips, office furniture, and teachers’ salaries to motorway construction. Hence, contractionary fiscal policy will involve a cut in funds appropriated to the various agents, thereby reducing aggregate production, income and inflation rates. Consequently, this policy is not easy to carry out as it is unpopular. Hence, governments are not keen to employ it due to its adverse short run results, which have political repercussions.
Policy makers tend to favour tinkering with taxes instead, which when being raised as in contractionary fiscal policy, are also unpalatable for governments. This mostly involves the raising of the income tax rate or a one time surcharge. An increase in taxes results in lower disposable income causing people to decrease their consumption. Furthermore, the decrease in consumption means a decrease in demand and a corresponding decrease in output and income. On an IS-LM curve, the effect is a shift upwards and to the left of the IS curve and a movement along the LM curve. Due to the reduced income there is less demand for money, resulting in a decrease in interest rates. Hence, it follows that, in the short run, a reduction in the budget deficit leads to reduced spending, accompanied by a contraction in output. However, in the medium run, output eventually returns to the natural level of output by adjustments through changes in the price level. This is dependent on the level of productivity (as a given) and the natural level of employment. Thus, the price level...

Find Another Essay On To What Extent Does Contractionary Policy Contribute to a Decline in Economic Activity?

Asian economic crises: What were the causes and consequences? To what extent does their occurrence relate to globalization?

1853 words - 7 pages disaster, was it related to globalisation? Well it was certainly related to economic globalisation. Globalisation in a sense is just a social change; it's an increased connectivity among societies. What happens in one society or country will have a direct or indirect affect on the other country. Now that we have easy access to other countries, we have easy access on information through better communications, the internet it has allowed us to

Does social responsibility in a business contribute to its profits?

1062 words - 4 pages the freedom of others.There is a strong positive relationship between levels of social responsibility and ethic. Social responsibility has become increasingly important in order to strengthen firm value. the social responsibility's role, one must first introduce the environment, the successful modern organization and the effect changes have had on these organizations. The role will be defined and then supported by further research into what

To what extent did Nazi policy result in a 'social revoltuion' in the lives of women?

1498 words - 6 pages The Nazi regime changed the lives of German's in many different ways. One of the most targeted groups within society were German women. However, it has long been debated whether a social revolution ever happened in German women's lives during the Nazi period, and if so, to what extent the Nazi regime revolutionised women's lives.The first view that historians put across is that there was a complete revolution in the lives of German women during

To what extent is writing on these subjects grounded in earlier traditions and to what extent does it enter a political debate, either explicitly or implicitly?

2322 words - 9 pages Nature was a subject most frequently used by poets of the 1930s to help communicate their political views and convey the alteration of which politics created in society. Writers sought after the public to be aware of 'the clashes between Fascism and Communism, dictatorship and social democracy and 'micropolitical' concerns' , which concerned all social classes well being. To exemplify what it is meant by the above, the analysis of the following

To What Extent Does Friedman’s ‘Efficiency Per

3080 words - 12 pages To what extent does Friedman?s ?efficiency perspective? provide foundation for responsible and moral international management behaviour? Need we have any concern if it fails to do so? In this essay I evaluate Milton Friedman?s essay: ?The Social Responsibility of Business Is to Increase Its Profits? in 1970, on the Social Responsibility of a business and his theory, which is called the ?Efficiency Perspective?. In every article and book that I

To what extent did economic considerations influence the American decision to go to war in Korea?

2267 words - 9 pages Although Acheson's "Defensive Perimeter" speech in Jan 12, 1950 did not include Korea, when the war broke out the US was involved immediately. The aim of this investigation is to find out to what extent did economic reasons influence the USA's decision to go to war in Korea. The main sources will be books that relate to the Korean War. Internet sources will be used if it is necessary for the summary of evidence. In B, the changes of the American

To what extent does Franklin D Roosevelt deserve to be considered a 'great' president?

2280 words - 9 pages To what extent does Franklin D Roosevelt deserve to be considered a 'great' president?During the time that Roosevelt was president he faced the two greatest crises of the twentieth century, namely the great depression and World war two. Some have labelled him one of the greatest presidents of the United States of America others have referred to him as the plague that the U.S could not get rid of, since he was the only president to be elected

To what extent did the Federal Government contribute to the Civil Rights Movement.

1358 words - 5 pages anti Dixiecrat politics raised media attention toward racial issues. This was important for the progress toward racial equality. In this essay I will discuss and eventuate how successful different parts of the federal government were and what each president or body did to ensure change in AmericaThe strongest force, in my opinion, was the Johnson administration (1953-1961); Johnson was the most radical of the Presidents and during this period used

To what extent does social class continue to affect voting behaviour in Britain?

3507 words - 14 pages purely with the class basis for the decline in allegiance, whereas Partisan Dealignment does not concern itself with class, but with an individual's or a group's psychological, ideological or electoral attachment to a party.The 1997 General Election was a landslide victory for the Labour party, not much different in 2001 election. Labour swept to power with a majority of 179 in 1997 (the largest for any Government since 1935 and the largest in the

Why does Gladstone decide to join the Liberal party (England) in 1859 and what does he have to contribute to Liberalism?

755 words - 3 pages Gladstone's transition from Tory to Liberal was certainly not an erratic decision made overnight. His drift from the high Toryism of his youth began in the 1840s and found final confirmation in 1859 when he quit the Conservative Party to join Palmerston's government. The shift in outlook reflected the combined effects of a new conception of religious freedom, the influence of Peel and the principle of nationality.The first of these liberalizing

To What Extent Can the Problems of Urbanization Be Met by a Policy of Sustainable Development

1577 words - 6 pages lightening traffic problems. So from this point of view, a policy of sustainable development can largely reduce the use of private cars. The data of urban public transit in most cities is positive and “this reflects their cities’ overall plans and priorities to achieve this”. In detail, although the amount of transit in US is low, it's growing again. The growth in transit in European and Asian cities is accelerating. Such trends are positive for

Similar Essays

To What Extent Does Globalization Contribute To Sustainable Prosperity?

1340 words - 5 pages Sustainable prosperity is a very controversial topic. There are a lot of differing opinions about what it is or how it affects us. What is sustainable prosperity? Let’s break it down. Prosperity, it is the idea that all humans needs are met, and they are able to follow a life of happiness. Sustainability, means being able to continue something over generation after generation. We live in a globalizing world today, but to what extent does

To What Extent Did Economic Problems Contribute To The Collapse Of The Weimar Republic?

1859 words - 7 pages November 1918 would inevitably fall as a result of numerous issues. However, the extent of which economic problems had in the dissolution of the republic, and how these issues caused or came about due to separate concerns faced by the new democratic system became a major contributing factor. Economic problems were evident before the new constitution was even drawn up, and already the new republic faced a host of problems upon proclamation

"A Successful Economic Policy Was The Key Behind Hitler´S Maintenance Of Power In Germany." To What Extent Do You Agree With This Statement?

990 words - 4 pages Dunia Malezai "A successful economic policy was the key behind Hitler´s maintenance of power in Germany." - To what extent do you agree with this statement? Hitler maintained power in Germany through a number of different measures. The successful economic policy, however, was the most important of all. The economic chaos in Germany after the Wall Street Crash of 1929 and the overall economic instability of Weimar Germany was a perfect

'indicate Left And Turn Right'. To What Extent Does It Represent Blair's Policy?

1958 words - 8 pages 'betraying' the social democratic ideology is worthy of assessment. But what is the basis of such a point of view? Is it facts, acts, and surveys or merely prejudices? More generally, in order to better situate the New Labour in power on the political spectrum, I will try to analyse its domestic decisions and results concerning firstly the economy, then the welfare state and unemployment, and finally trade unions and their influence.Economically Blair