Expansionary fiscal policy, such as the Chancellor of the Exchequer deciding to reduce the standard rate of income tax leads to higher aggregate demand and an increase in equilibrium income and output. In this essay I will examine the factors that are important in determining the macroeconomic effects should such a policy be installed by Gordon Brown (Chancellor of the Exchequer), and I will comment on any suggestions I may have for Gordon Brown in the preparation of his next budget with a brief description on the assumptions that my advice is based.
Firstly I would like to examine the macroeconomic goals/aims of Gordon Brown and his fiscal policy. Fiscal policy is the governments plan for spending and taxation, it is designed to steer aggregate demand in some desired direction, which we will investigate in greater detail later on today. Macroeconomic policy is a phrase used to describe actions taken by governments to manipulate the economy to influence the level of inflation and unemployment. Along with balance of payments and high stable economic growth, low inflation and high employment are two of the main four macroeconomic goals of the government. In practice, macroeconomic policies could be used to refer either to policies sought to influence aggregate supply or to policies that sought to influence aggregate demand. We will investigate aggregate supply and aggregate demand both in the long run and in the short run and show their effects on macroeconomic policy.
Aggregate Supply and Aggregate Demand
Aggregate Demand and Aggregate Supply in the Long Run as shown in Figure 1
In this graph we can see that as a result of a decrease in income taxes, aggregate demand will shift to the right from AD to AD1. Aggregate supply in the long run is a vertical line that keeps Y at the natural rate of Y*, which inturn produces constant output and increased prices which is an a...
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