When we talk about how fiscal policy affects the macroeconomy, we are generally thinking about its impact on aggregate demand. However, fiscal policy can also have an impact on aggregate supply. The impact on aggregate demand is more direct and it occurs more quickly while the impact on aggregate supply is indirect and tends to happen only over a longer period of time. Let us look at three ways in which fiscal policy can have an impact on aggregate supply.
First, fiscal policy can create more capital. One aspect of fiscal policy is government spending. Some government spending goes to things like building roads and other types of transportation facilities. When the government spends money in this way, it can increase aggregate supply. It does this because building roads makes it easier to move things from place to place, thus making it easier for businesses to get materials they need and to get their products to their customers.
Second, fiscal policy can impact the amount of work that is done in the economy. Some economists believe that lowering taxes will create more of an incentive for people to work. If people can keep more of the money that they make, the theory goes, they will work more hours. When this happens, aggregate supply will increase.
Finally, fiscal policy can lead to greater innovation. For example, if taxes on businesses are lowered, they will have more money to put into research and development. If they use their money in this way, they will tend to develop new products and new techniques. Doing so will allow them to produce more things, thus increasing aggregate supply.
In these ways, fiscal policy can affect aggregate supply, though the impacts will not be very direct or very immediate.