Fiscal policy is the use of the government spending as well as tax policies to create an impact on the macroeconomic conditions, which comprise employment, the aggregate demand AD, economic growth, as well as inflation. The Japanese government intends to use this tool to help the country economies in coordination with the loose monetary policy. The only problem with this policy is that the spending levels have not been mentioned but instead, it lists the principles, which must be followed for the next year’s budget. This brings uncertainty in the way the banks in Japan will be able to maintain its monetary easing program.
The expansionary fiscal policy that will be adopted by the government of Japan will seek to expand the supply of money in the economy, which will encourage economic growth and eradicate the increase in prices because of inflation. One of the ways that can be employed by the government includes rebates, transfer payments, and tax cuts. The central bank can also affect the open market operations based on the interest charged. By cutting the tax the cost of production will be low hence more goods and services will be produced. As a result, the prices of goods and services will be lower due to forces of supply and demand in the market. The aggregate demand will therefore, increase among the people since the budget line will be able to accommodate more commodity bundles, which were not possible when the prices were high due to high taxes. From the graph, when the tax is cut, the disposable money will be more in the economy hence the increase in the price of the goods and services will be covered by more money in economy hence AD shifts from AD1 to AD2.
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"Commentary on “Japan looks to Increase Role of Fiscal Policy in Next Budget”".
The increase in the amount of spending by the government on the infrastructure would create more employment for many people who were not employed either directly working on the infrastructure projects or doing business using the established infrastructure. During this time, the per capita income among the population will increase because of the multiplier effect, which arises due to the rise in the final income from any new injection from spending. Since there is more disposable income among the population, the commodity bundles that can be purchased by the people will increase as they are in a position to pay for them. This, therefore, leads to an increase taken together demand. Nonetheless, the increase in the government spending might increase the budget deficit as well as the national debt. This is because the government may have to seek financial assistance from foreign countries that will have to be repaid by the government.
The reduction of tax by the government will motivate more investors to obtain loans from the financial institutions to expand their investments. This will increase the level of production due to the availability of capital that can be used to purchase required raw materials and pay for the labour. Due to this, the level of supply of the goods and services will be high in the market, which is also the case with the level of disposable funds since many people have been employed in the production firms. The pressure of inflation is dampened by the fact that there is an increased production of goods and services due to increased investments. This is illustrated by the graph below where the initial aggregate demand before the tax cut was at the AD, however, the increased supply of goods and services due to increased investment will be absorbed by the increased disposable income hence making the aggregate demand to shift to AD2.
