Some economists argue that fiscal policy is an ineffective form of government intervention. Discuss fiscal policy and its effectiveness in stabilizing the economy.

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Economics- CIA 4U0

Final Summative Evaluation

Part A – Essay

B) Some economists argue that fiscal policy is an ineffective form of government intervention. Discuss fiscal policy and its effectiveness in stabilizing the economy.

Malvinder Garcha

CIA 4U0

Mrs. Wallace

Due: Friday, January 20th, 2006

Effectiveness of Fiscal Policy

As an economy experiences periodic swings in aggregate demand and real output throughout its business cycle, the government must intervene and dissolve the instability through means of policies; but this was not always thought to be the solution. From the years 1929-1939, the world experienced a global recession for the first time in history, known as the Great Depression (). The depression stunted every aspect of economic growth as banks failed, unemployment was high, GDP drastically dropped, and the stock market plummeted; leaving economists in disbelief. Theories of all sorts varied from economist to economist, but some, such as that of Adam Smith, were greatly emphasized. Smith believed in the laissez-faire, “leave to do”, economy in which he believed that the “an economy operates best if individuals are allowed to pursue their own self-interest without government intervention” (Bolotta, 454). This theory, as well as those of many other economists were proven wrong by the Great Depression as it showed how without government intervention, the economy is left unregulated and without guidelines. This, in turn, led to the need for government intervention to avoid further economic failure. The government began to create policies in order to regulate and control the economy and its activities, which led to the creation of the fiscal policy. A fiscal policy is “the use by a government of its powers of expenditure, taxation, and borrowing to alter the size of the circular flow of income in the economy so as to bring about greater consumer (aggregate) demand, more employment, inflationary restraint, or other economic goals” (Bolotta, 230). Within the fiscal policy are automatic stabilizers which help the economy smoothen any fluctuations it may encounter, therefore making it effective. Another component to fiscal policy, discretionary fiscal policies, allow the government to deliberately take action to stabilize the economy through taxation or spending policies. Through the use of fiscal policy, an economy possess a powerful effect tool with which it is able to avoid large cynical swings and fluctuations throughout business cycles.

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Smith’s laissez-faire economic basis of letting the economy run itself without intervention by the government due to fear of dwindling of the economy itself was widely preached until the Great Depression. It was not until after the depression that the people began to realize that government intervention was necessary and crucial in ensuring economic prosperity and expansion towards a healthy economy. Automatic stabilizers within a fiscal policy allow for the combination of both the pre-depression and post-depression views on government intervention within an economy. Automatic stabilizers are defined as “mechanisms built into the economy that automatically increase aggregate demand ...

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