Failure of Activist Fiscal Policy System †MyAssignmenthelp.com

Question: Discuss about the Failure of Activist Fiscal Policy System. Answer: Introduction: The unhealthy food habits increases government expenditure on health and services. To address this use the tools of subsidy and tax should be used in combination (theconversation.com 2017). Subsidy and taxes though both has distortionary effect but both can alters buying habit by changing prices paid by the consumers and that received by the sellers. First, consider the effect of taxation on unhealthy food like sweet and sweet beverages. The own price elasticity estimate for sweet and sugar snacks are -0.270 and -0.295 for high and low calorie sweet and sugar snacks respectively. Therefore, the demand is inelastic in nature and hence, the demand curve is steeper. Before the imposition of tax P* and Q* denotes the respective equilibrium price and quantity. Imposition of tax raises price paid by the consumer to P1 and the price received by the producer is P2. Because of inelastic demand, the consumers bear a greater tax burden. High calorie food and vegetables have a price elasticity of -1.128 and low calorie dairy products have elasticity of -1.972. When a subsidy is given then price paid the consumers decreases while that received by the producer increases. A subsidy on these products will increases demand of these foods by a proportion greater than the price decrease. Keynes suggested government intervention is needed in an economy to stand up shocks. The Keynesian view received great appeal in times of Great Recession. In times of recession, the economy face a depressed demand because of a reduced consumption spending. Spending is an important component of aggregate demand. The idea is to give private spending a boost through an increase in government spending. The assistance provided by government either directly or indirectly increases spending of household and private expenditure and therefore results in a increases in aggregate demand. The fiscal reliance was given priority as then no monetary authority or central bank to design monetary policy was at existence. In time of recession the economy contracts. Automatic fiscal stabilizers are those works without active intervention by the policymakers. As the income reduces, people pay less tax. Which shrinking employment opportunities, government needs to pay more transfer payment. The changes in tax revenue earned and government expenditure bring automated change in budget. The discretionary changes on the other hand take place in the form of change in tax rates or government expenditure. In times of recession government increase their spending and reduces tax rates. The overall government spending in OECD region during economic downturn has increased from 25 percent in 1960 to 40 percent today (cis.org.au 2017). Fiscal contraction taken place in the form of reducing wasteful expenditure improves economic performance. In times of fiscal contraction, a crowd in effect in investment in realized because of the operation in the money market. The money market instrument that works in force is the interest rate. Because of fiscal contraction, interest rate prevailing in the money market reduces (cis.org.au 2017). This stimulate real investment by reducing borrowing cost. Investment being a component of aggregate demand or national income results in an increases in economic activity. This also strengthens the external position of the by strengthening exchange rate and fosters net export and national income. Monetary policy gives stimulus to the economy by boosting investment and aggregate demand. Under expansionary monetary policy, there is a reduction in interest rate through increasing money supply. The reduced interest rate increases investment in the economy because of a reduced borrowing cost. When interest rate reduces, then there is a depreciation of currency (cis.org.au 2017). With currency depreciation, export becomes cheaper and therefore fosters export. With improvement in net export national income increases and the economy expands. The stimulus given from the fiscal policy does not consider the fact that the economy of Australia largely dependent on external borrowing. The foreign borrowing enters through the channel of banking sector where interest rate plays an important role. References Cis.org.au. (2017).Fiscal Fallacies : The Failure of Activist Fiscal Policy. [online] Available at: https://www.cis.org.au/publications/policy-forum/fiscal-fallacies-the-failure-of-activist-fiscal-policy/ [Accessed 24 Oct. 2017]. The Conversation. (2017).Why the government should tax unhealthy foods and subsidise nutritious ones. [online] Available at: https://theconversation.com/why-the-government-should-tax-unhealthy-foods-and-subsidise-nutritious-ones-72790 [Accessed 24 Oct. 2017].