The fiscal policy influences aggregate demand, wealth distribution, and the capacity of the economy to produce goods and services by the fiscal policy (Ross). In the short run, changes in taxation or spending can alter the demand pattern for the goods and services. Resources are any productive factors that are needed to accomplish any activity of the business while capital is the financial value of the assets. Therefore, with time, the aggregate demand will influence the allocation of resources, and the production capacity of the economy via its impacts on the returns to production factors, human capital development, capital spending allocation, and investment in technology. The effects of tax rates on the net return to labor will consequently influence savings as investment affects the magnitude and allocation of productive resources.
The main reason for the shift in Production Possibility Frontier (PPF) is due to the change in technology, and economic growth (Hubbard et al.) This implies that when everything is held constant, there will be a production of more goods after the technological change. Moreover, the outward shift may be as a result of economic growth that permits the production of both capital and consumer products. Similarly, as the capital grows over time, then we could see an outward shift in the PPF curve representing greater possibilities of production.
When capital investment increases, it will allow for more research and development in the structure of the capital. Consequently, the expansion of capital structure will raise the production efficiency of labor. Therefore, as labor becomes more efficient, more goods and services will be produced. That is there will be higher growth in the domestic product (GDP), and this will make the economy grow. Similarly, as the capital goods improve, there will be an increase in labor productivity. Therefore, superior equipment of capital will make individuals, businesses, and nations to be more efficient in production and this will boost the living standards which is the purpose of economic growth.
The increase in real interest rates will stabilize the economy concerning investments because it will give higher incentives for saving rather than consumption. Consequently, most people will start saving in financial institutions such as banks. This will compel the banks to make additional lending to the people, hence, driving down the rate of interest and raises the level of investments. When the interest rate decreases, the cost of borrowing will be low, and this will encourage people to increase their investment spending. Similarly, low-interest rates provide more incentives to the banks which later lend business owners to allow them to make more expenditure.
When the deficit budget of the government shrinks, the demand for loanable funds will change to the left and the interest rate at the equilibrium drops. Therefore, the investment will increase due to low-interest rates. In conclusion, fiscal sustainability arises when the state able to sustain its current spending, and tax for long without affecting its ability to pay debts and other financial obligations. When the government makes more expenditure, then it has plans to recover from tax revenues each year. Therefore, long-term fiscal sustainability will only take place when tax and policies of spending are aligned. According to the McKinsey Global Institute, long-term fiscal sustainability is essential to the growth of the economy because it will not increase the national debt at each period.
Bibliography
Hubbard, Glenn et al. Macroeconomics. United Kingdom: Pearson, 2014. Print.
Ross, Sean. "How Does Total Capital Investment Influence Economic Growth? | Investopedia". Investopedia. N.p., 2015. Web. 29 Mar. 2016.
