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Fiscal Policy in the United States

When the US suffered a severe recession in 2008, the country’s legislative institution, the U.S. Congress, passed a law allowing the federal government to increase its spending and reduce the taxes. Fiscal policy has become a fundamental policy tool in tackling the aggregate demand outcomes of the financial crisis that have hit the U.S. on several occasions. In any economy, when the government expands its spending, the GDP of that country will increase while the level of unemployment will go down. However, fiscal policy does not always produce positive effects, as an increase in national output (GDP) causes inflation in the short run. This study will focus on how government spending affects economic performance of a country.

Recessions cause a decline in real GDP, and when real GDP falls, households will not be motivated to spend. In such situations, the government is forced to increase spending to stimulate consumption. Any time the federal government raises its spending, the collective demand increases in the short run. This will consequently result in the aggregate demand curve shifting towards the right, as the equilibrium price increases. The real GDP will swell with rise in government spending.

Rise in government spending influences productivity levels in the economy. A swelling in productivity causes a shift in collective supply towards the right. This implies that the economy will experience technological improvement, more competent workers, and adequate funds for research and development. Consequently, the level of unemployment will fall, and the standard of living will rise. A rise in productivity is an assurance of a stable economy in the long run. However, an increase in spending by the government causes inflation, which tends to inhibit the purchasing power.

Taxation has a negative effect on the summative demand. Taxation causes a reduction in disposable income for consumers, as much of their income would go to the government as tax. Taxation also reduces profits in private businesses, which lead to low investment, thus, an increase in taxation creates a reduction in aggregate supply. Fiscal policy advocates for a cut in taxation to encourage consumption. A reduction in tax causes aggregate demand curve to shift toward right, as consumers create more demand due to higher disposable incomes. Tax cuts will also cause a shift on aggregate supply, as the price levels of goods supplied to the customers are expected to fall due to high demand.

 A government that runs on budget deficit is likely to experience a stimulating effect. Increased spending by the government, as well as decreasing taxes as proposed in the American Recovery and Reinvestment Act (ARRA) of 2009 aimed at creating new jobs for Americans, enhance economic activities for long-term growth, and create transparency in government spending (Hall & Jennings, 2011). The ARRA proposed a tax cut to benefit families and businesses, as well as financial support for federal contracts and loans.

Increases in spending by the government facilitate consumption and job creation, as the private sector is motivated to expand its business ventures. Tax cuts increase household income, in addition to encouraging people to work so that they can save much of their income. A tax cut encourages investment, as businesses will enjoy higher profits. Private sector is encouraged to hire more people when tax is reduced.  Although the ARRA failed to achieve much of what it had promised, it managed to avert a second recession and saved approximately 1.6 million jobs per year for a period of four years (“What the stimulus accomplished,” 2014).

Fiscal policy is one of the major reasons why Americans have developed hatred toward Congress due to the risks that it carries. According to The Economist, Republicans have been in fierce battle with Democrats since 2010 due to matters concerning national debts, fiscal cliff, and a 16-day government shutdown (“The governance test,” 2014). Before the end of 2014, Congress is supposed to pass laws on what the government should spend, as well as the level of taxation.  However, lack of information by the government on the country’s economy can make fiscal policy produce negative results. If the government anticipates a recession, it may opt to increase the aggregate demand to trigger consumption. However, if the anticipation is wrong, and the country’s economy develops quite fast, an increase in aggregate demand would lead to inflation.

Expansionary fiscal policy leads to budget deficit, which, consequently, can lead to higher taxes in the future. Critics of fiscal policy asserted that borrowing by the government to increase its spending will increase the aggregate demand, but will create very little effect on real GDP. This is due to the crowding-out effect, which reduces the stimulus to aggregate demand leading to reduction in spending by the private sector (Tucker, 2014). Crowding-out effect involves reduction in spending by private sector due to higher interest rates charged by the Treasury to finance government spending. 

In conclusion, fiscal policy has contributed much to the recovery of the US economy, despite complaints by Republicans that it has failed to stimulate the US economy. Increase in government spending causes rise in real GDP, thus encouraging consumption, while tax cut increases disposable income and saving. However, fiscal policy is not always the best option, as it can lead to inflation and low investment. When unemployment occurs due to decline in private sector spending, the countercyclical injection of equal amount by the government does not provide an assurance of a return to the same level of employment (Tcherneva, 2012). Lack of incentives to private sector discourages investment, while more people would remain unemployed. 


Hall, J. L., & Jennings, E. T. (2011). The American Recovery and Reinvestment Act (ARRA). Public Performance & Management Review, 35(1), 202-226. doi:10.2753/PMR1530-9576350110

Tcherneva, P. R. (2012). The Role of Fiscal Policy. International Journal of Political Economy, 41(2), 5-25.

The governance test (2014, November 8). The Economist. Retrieved on 11 Dec. 2014 from

Tucker, I. B. (2014). Macroeconomics for today. Mason, OH: South-Western College.

What the Stimulus Accomplished (2014, February 22). The New York Times.Retrieved on 11 Dec. 2014 from