Fiscal Policy Is a Very

Fiscal policy is a very powerful tool the government uses to alter macroeconomic variables such as the level of GDP, employment, or the price level. The instruments with which fiscal policy is built are taxes, government purchases, transfer payments, and borrowing. All of these can be used in multiple ways and their proper implementation may seriously affect a country's macroeconomic environment -- fiscal policy may lead an economy out or crisis or may bring a booming economy to total disaster.

The main tools of fiscal policy are automatic stabilizers and discretionary fiscal policy. Automatic stabilizers are those structural features of government spending and taxation that help ease the fluctuations in disposable income. Therefore, consumption is also regulated over the business cycle. A progressive income tax, for instance is an automatic stabilizer. If people are earning more money and the economy is at its height, the state has all the reasons to collect higher taxes. Beside the definite advantages for the state budget, people are less encouraged to consume. On the other side, if the economy is facing recession, wages will be lower and therefore tax quotas will also go down. As a consequence, people will be encouraged to spend more. This is the reason for which a progressive income tax is considered an automatic stabilizer.

Unemployment insurance may also be an automatic stabilizer. In times of recession, when unemployment increase, insurance funds which were constituted prior to the recession years make payments to those who are unemployed. The direct effect is that there disposable income increases, so the impact of the recession is not felt so fully. Increase in consumption may bring new investments and the economy should go back to normal.

Regarding the effect on automatic stabilizers on the Gross Domestic Product, it should be noted that GDP will fluctuate less than it otherwise would, and that the disposable income will vary proportionately less than real GDP does. Automatic stabilizers are very powerful fiscal tools which, if used properly may limit the need for discretionary fiscal policy

A second tool is the discretionary fiscal policy, which is the deliberate manipulation of taxation, transfers and government purchases with the purpose of promoting macroeconomic goals such as economic growth, full employment, and price stability.

A change in government purchases for instance works as follows:

( Real GDP = (G * (1/1-MPC) where (G is the surplus or decrease in government spending and ( Real GDP is the effect on the GDP.

Another method implied by discretionary fiscal policy is the change in net taxes. A decrease in net taxes, for instance, leads to an increase of disposable income. As a consequence, consumption increases and real GDP increases also.

On the other hand, should the net taxes rise, people will have less money to spend, which means that there disposable income affected to consumption will also decrease. Lower consumption will automatically lead to a decrease of the real GDP.

The formula with which this effect may be calculated is as follows:

( Real GDP = (NT * (-MPC/1-MPC) where -MPC/1-MPC is the value of the simple tax multiplier, which represents "the ratio of a change in equilibrium real GDP demanded to the initial change in autonomous net taxes that brought it about."

It should also be noted that an increase in government spending lead to the increase of equilibrium real GDP demanded. In such a case, the government purchase multiplier is greater than 0. An increase in net taxes, on the other hand decreases equilibrium real GDP demanded. The simple tax multiplier is in this situation negative

Fiscal policy has had a very interesting evolution. The first views regarding how the state should spend its money were heavily influenced by liberalism. Classical economic thinkers believed that the economy should stabilize all by itself, according to the rules of offer and demand and that the state's interference would only bring a deterioration of the economy's health. State resources should have been spent, in their opinion, only on public services which were absolutely necessary, such as the administration, the justice system or the armed forces.

This was the view whereon public policy was based before the Great Depression. The sole object of fiscal policy was to balance the budget. 18th - and 19th- century economists believed that recessions were short-run phenomena which had the ability to correct themselves through natural market forces -- the essence of their thesis is that the economy was in their opinion, self-correcting. The source of most economic crises was believed to be other than market forces. For instance, subjective factors such as wars, changes in tastes and poor growing seasons where sometimes blamed for ill times. The market would correct these temporary problems (recessions or inflation) without any help from the state. An active fiscal policy would do more harm than good, according to these assumptions.

The Great Depression changed all that. It became clear that the state had to be more actively involved in the development and control of the economic situation in order to stop or at least limit the effects of highly negative phenomena, such as unemployment and inflation. The era of classical economical thought was over.

There are multiple factors that determined an increased use of discretionary fiscal policy. The English economist John Maynard Keynes presented in 1936 his general theory on the use of money labor and capital. His theories and policies were developed as a direct result of the Great Depression and addressed problems that have arisen during those very difficult years, such as handling unemployment issues.

One of the arguments he made was that prices and wages weren't flexible enough to ensure full employment of resources. Resources are only in theory directed to the place in the economy were they are needed most. Market forces, no matter how powerful, cannot fully compensate for this lack of flexibility. Therefore, a state intervention is sometimes needed to correct the disequilibrium generated in the economy. He also said that, sometimes, business expectations might be so grim that investments might not come at all, although, according to the classical view, firms should begin spending money.

Another factor which determined use on a larger scale of the discretionary fiscal policy is the fact that the global economy was pulled out of depression and cyclical unemployment was eliminated because of increased war production during 1939-1945.

These changes were also seen in the legislation of the time. The 1946 Employment Act brought a new fiscal policy vision and made the federal government responsible for promoting price stability and full employment.

Regarding the impact of fiscal policy on the Gross Domestic Product and JP Morgan Chase bank, it should be mentioned that the bank would be affected just like any other organization conducting its activity in that particular economy. There are however some aspects that need further analysis, since JP Morgan Chase is not an ordinary company, but a credit institution.

Let's suppose that the state uses an automatic stabilizer such as an income tax. In times of economic boom, taxes will be high and disposable income will diminish. However, since confidence is high, people will be inclined to take more credits from the bank, which will lead to an increase of the monetary mass. This increase may not be fully associated with that of the GDP, and unless the central bank does not intervene and limit granting of credits, the economy may find itself faced with inflation. The bank will have no reason to complain, since its business is doing well. Suppose unemployment insurances are wide spread. The company which manages that particular fund may ask the bank for advice regarding how to invest the money or may deposit the amount with the bank, which is also a good thing for JP Morgan.