Changes in the level and composition of taxation and government spending can impact the following variables in the economy: aggregate demand and the level of economic activity; the pattern of resource allocation; and the distribution of income.
Economic Effects of Fiscal Policy Governments use fiscal policy to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment, and economic growth.
One school of fiscal policy developed by John Maynard Keynes suggests that increasing government spending and decreasing tax rates are the best ways to stimulate aggregate demand, and only to decrease spending & increase taxes after the economic boom begins.
Keynesian theory posits that removing spending from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices.
This causes a lower aggregate demand for goods and services, contrary to the objective of a fiscal stimulus.
Changes in the level and composition of taxation and government spending can impact the following variables in the economy: Aggregate demand and the level of economic activity; The pattern of resource allocation; The distribution of income.