Private investment has great significance for the growth and development of an economy specially that of a developing country. Changes in the economic policies are equally important for the investment as it is for the growth of the economy. Fiscal policy has a strong relation with the growth of economy and the most important element for this relation is private investments. Fiscal policy refers to the use of revenues collected by the government through the taxes and the spending by government to affect the economy. With the interaction of the government activity with the private sector, a positive effect is seen on the total output. Corporate profits and private investment are affected with a change in taxation and government expenditure (Dunstan and Hargreaves et al. 5-18). By taking decision on fiscal policy, the government can help in smoothening the business cycles.
The fiscal policy impacts the aggregate demand of the industry. Due to the multiplier effect, the change brought to the aggregate demand is much greater than the change in the expenditure of government. When the government increases the expenditures or lowers the taxes, the expansionary fiscal policy is said to have been implemented; the purpose of this policy is to raise the level of output or to improve the aggregate demand (Barseghyan and Battaglini et al. 2223-2265). With the rise in aggregate demand of the goods and services, the businesses respond by raising the level of investments. When demand rises, the need to produce more rises, more investment is used for this purpose. To produce the required output, more workers are hired that in turn improves the level of employment in the economy.
When the business invests in human resource, the number of employed workers increases and so does the amount of income that can be spent. When these workers spend their income in the market, further demand for the goods and services rises that means the aggregate demand would rise when the number of employed workers increases. As more demand is created, more output is required by the businesses to meet the aggregate demand and hence, the businesses require investing more into the economy. This cycle continues, as more investment leads to more hiring and raising the levels of employment that further leads to increasing the spending and creating a higher demand; so, with the multiplier effect, a decision made by the government creates a multiple effect on the business investments leading to an economic growth (Dunstan and Hargreaves et al. 5-18).
The other type of fiscal policy is the contractionary fiscal policy; it is the opposite of the expansionary fiscal policy. It refers to raising the taxation and shrinking the government expenditures. It affects the aggregate demand negatively influencing the profits negatively that in turn reduces the need to invest further in businesses. Fiscal policy can also affect the private investment by raising the investor confidence on the consistency of the government policies (Afonso and Sousa 4439-4454). By tight fiscal policies, the level of private investment can be positively influenced; it can increase the total domestic savings while dipping the rates of interests and hence, the volume of savings shall be increased that can be invested in private businesses. The contractionary fiscal policy is also used for combatting the inflation. When the government reduces its expenditures, its borrowing is also reduced; it results in an increase in the funds supply that is available in the credit market causing a decline in the interest rates. In the private sector, the investment increases because the aggregate demand rises.
If the interest rate increases, the cost of borrowing money rises and so, businesses tend to invest less. An increase in interest rate also means that the business has to pay more for the existing debt that eventually reduces the amount of available investment. Further, the cost of production in the private sector is reduced when public services are provided by the government that leads to driving the private profitability positively and hence, leading to a rise in private investments. These are some of the effects that fiscal policy has on private investments.
In conclusion. There is a very significant impact of the fiscal policy on the private investment in businesses. Fiscal policy involves changing the decisions about the taxation and the expenditures by the government. There are two kinds of fiscal policies: the expansionary fiscal policy is used to trigger economic growth while the contractionary fiscal policy is used to combat inflation. In the expansionary fiscal policy, the level of output increases leading to a rise in the private investments. On the other hand, the contractionary fiscal policy leads to a decline in the aggregate demand and therefore the need to invest declines.
Works cited
Afonso, Ant'Onio and Ricardo M Sousa. "The macroeconomic effects of fiscal policy." Applied Economics, 44. 34 (2012): 4439--4454. Print.
Barseghyan, Levon, Marco Battaglini and Stephen Coate. "Fiscal policy over the real business cycle: A positive theory." Journal of Economic Theory, 148. 6 (2013): 2223-2265. Print.
Dunstan, Ashley, David Hargreaves and Ozer Karagedikli. "The impact of fiscal policy on the business cycle." Reserve Bank of New Zealand Bulletin, 70. 1 (2007): 5--18. Print.
