Fiscal Policies

Fiscal Policy is defined as the deliberate change in either government spending or taxes to stimulate or slow down the economy (Colander, 2004). The effects of the changes in fiscal policy in the simulation had an effect on government expenditure and taxes. Making the right decisions about government expenditure and taxation will help the economy achieve the desired potential output in the long run. In the first scenario, as President I had to decide what would be the best way to fight off a recession without increasing the budget deficit higher than 5% of the gross domestic product (GDP). I had to decide on three alternatives which were, change in government spending on infrastructure, education, or income tax rates. I chose to increase the spending on infrastructure by 300 million. Increasing this policy led to increase in real GDP by 41.20 billion and therefore to an increase in real income and a fall in unemployment. Unfortunately, my decisions did raise inflation a little by 5%. On the other hand it helped increase my popularity as President. When the economy is in recession the best decision is to raise expenditure or taxation or both. If expenditure is not increased then the economy’s developmental needs will not be satisfied. Increasing the expenditure was better than investing in education because developing infrastructure to connect different parts of the economy is crucial to the country. Investing in education would not have helped because it still would not generate enough jobs in the small town of Erewhon. The majority of the people skills are in agriculture.

The next scenario involved a decision to decrease inflation which meant a decrease in the people incomes as well. Again I had to choose between government spending on infrastructure, education, or income tax rates. To reduce the inflation rate, I decided to increase the income tax rate by 3.5% which increased income tax revenues by 700 million. The reduction caused the budget deficit to reduce by 2.33% of the GDP. Real GDP was reduced by 41.26 which brought the budget closer to the economy’s long run potential output. Because the price levels are reduced inflation is lower. My decision to increase the income tax rate reduced inflation by 5.16%. However, the unemployment rate increased by 4.43%, which is not good for the economy.

In the final scenario, I have been reelected as President. I am still struggling to bring down inflation. I increased defense spending by 200 million and decreased spending on social welfare programs by 400 million. The change caused income tax revenues to increase by 200 million. The budget deficit reduced to 2.52% of GDP. The policies I chose led to real GDP of 41.48 billion which is not exactly the output expected in the long run but is still sustainable. Finally, inflation will reduce to 5.61% and unemployment will be at 4.16%.