Discuss the effectiveness of a fiscal policy in reducing unemployment

A fiscal policy is a type of government introduced macro-economic policy that aims to influence aggregate demand. The policy uses taxation and government expenditure in the form of a loose or tight fiscal policy.

A loose fiscal policy would be used to tackle unemployment as this involves cutting taxation and increasing government taxation, an increase in indirect or direct taxes and increasing government expenditure. This is effective policy in the sense that a reduction in taxation, in theory would increase consumer expenditure as since taxation is low, individual discretionary income would increase and be spent on purchasing goods in the economy.

There are however limitations to its effectiveness as it only potentially only deceases demand deficient unemployment but not any of the other three forms of unemployment: structural unemployment, frictional unemployment and real wage unemployment, which are mostly long term and will be better solved by the application of supply side policies. Fiscal policy would only be used as a short term solution to unemployment and is not sustainable.

There are other factors external to the fiscal policy that can limit its effectiveness such as interest rates. Interest rates ...

This is a preview of the whole essay

There are other factors external to the fiscal policy that can limit its effectiveness such as interest rates. Interest rates have substantial impact on the levels of spending by consumers. If interest rates are high a loose fiscal policy is introduced then the levels of consumer expenditure will not change dramatically. When interest rates are high, opportunity cost of spending is increased and therefore spending decreases, credit is also harder to obtain and investment will decrease. This actually serves to reduce aggregate demand and have the potential to increase unemployment.

Other factors also include the externally administered marginal propensity to consume as if the country has a low marginal propensity to consumer then consumers might not increase consumption of goods within the economy. Another factor affecting the effectiveness of a fiscal policy is the fact that a cut in taxes might be perceived by the population as temporary therefore consumer consumption will not increase.

As aforementioned, this type of policy is only effective in the short run as it is un-sustainable. The introduction of these policies will be potentially damaging in the long run. If the economy is producing on the production possibility frontier or at full capacity as shown above, an application of a loose fiscal policy will still increase aggregate demand but it will not increase employment but will only increase inflationary pressure and no economic growth.

In conclusion, the increase in government expenditure and cut in taxation will only be effective in a short run however there are limitations in its effectiveness as a time lag in the application, a fiscal policy will only be fully effective in normally two years and by then the situation might have changed. Other things external to the policy will also affect the fiscal policy such as the multiplayer, where if it is low, the introduction of a fiscal policy will only have a minimum impact on the economy and levels of unemployment.

There are better alternatives that can solve the unemployment problem, i.e. lower levels of unemployment such as the introduction of supply side policies, which are long term policies and is completely sustainable. It will solve all four main types of unemployment as it can potentially lower demand deficient, real wage, structural and frictional unemployment.

| Page

Peer Reviews

Here's what a star student thought of this essay

groat

12th of Mar 2012

Quality of writing

The structure here is strong, having a clear introduction and conclusion. I liked how the essay progressed from analysis of the mechanism, and then evaluating how effective it is. This style will ensure the marks are gained. Spelling, punctuation and grammar are strong and technical terms are used throughout. Although improvements can be made, what is evident here is strong!

Level of analysis

The analysis here is strong. The mechanism of how an increase in government spending and decrease in taxation is fully explored. I was impressed to see the accelerator model explored, and the awareness that labour is a derived demand. This incorporates various parts of the syllabus and meets the synoptic elements. Diagrammatical analysis is essential, and this essay shows potential. However, these diagrams are not explained and a simple sentence such as "An increase in government spending would lead to a shift in aggregate demand from AD to AD1, causing the real GDP to increase from Q to Q1. This should then increase the level of employment." Without using sentences like this, it is not clear you fully understand what the diagram represents. The evaluation and discussion of factors limiting the effectiveness is strong, including marginal propensity to consume and external factors. I would've liked to have seen the Keynesian long run aggregate supply (LRAS) curve used to allow a discussion of the effectiveness depending upon where the macroeconomic equilibrium is on the curve. There also needs to be a discussion of how large the increase in government spending (or reduction in taxation) is, lending itself to a discussion of the multiplier. Such analysis would've made these judgements stronger. The essay has the right idea in discussion what other policies are effective, but this needs to be made before a final conclusion. In my experience, examiners aren't looking for much discussion of other policies in this question. If it had said "Discuss whether fiscal policy is the most effective" then this would've been suitable.

Response to question

This essay engages superbly with the question. There is a clear understanding of fiscal policies, and how they can reduce unemployment. The essay then goes to further to evaluate the effectiveness of fiscal policies, looking at the limitations. This ensures the question is fully answered, and so this essay can access the higher marks. I would've liked to have seen a discussion of whether government spending, or taxation is the most effective in reducing unemployment. Such discussion would've shown a strong understanding of the question.

Did you find this review helpful? Join our team of reviewers and help other students learn