Fiscal Policy

What is fiscal policy

The use of government revenue (Taxes) and expenditure to influence a country's economy

Cons of expansionary fiscal policy

Very high demand pull inflation
CA and Budget Deficit
Worse Gov. Finances
Crowding out effect
X - inefficiency
Dependency - business and public become too reliant even in better economy
Time lags

Cons of contractionary fiscal policy

unemployment
Deflationary pressure - prices begin to drop to incentivise spending
Time lags

Demand pull inflation

When aggregate demand is more than aggregate supply - scarcity causes price increase

Crowding out effect

When gov. spending is debt fueled, equilibrium interest rates rise which crowds out the private sector and reduces investment

X-inefficiency (from gov)

gov. has no profit motive so is likely to waste resources and not use them as optimally as possible

Eval points

Output gap size → bigger gap = more effective

Multiplier size → greater impact if multiplier higher / cheaper for gov.

Consumer/Business confidence → lower confidence = less chance of investment

Gov. Finances → poor finances = less likely to be helpful as gov. will borrow more

LR gov. returns

Laffer curve - keep more income → work more → pay more tax

Automatic stabilisers

Crowding out vs In - high interest → high savings → more spending → more investing as there is more demand (classical vs Keynesian)

Reasons for expansionary fiscal policy

boost growth, Lower unemployment, increase demand pull inflation, redistribute income

Reasons for contractionary fiscal policy

Lower inflation, reduce budget deficit, redistribute income, lower CA deficit