fiscal policy

what is fiscal policy

the use of government spending and taxation to control the level of aggregate demand in the economy

purpose of fiscal policy 4

1. lower inflation- less spending more tax

2. economic growth. lower tax inc spending

3. stabilize economic growth

4. redistribution of income

three impacts of a increase in income tax

1. increase unemployment as tax increases, less spending- less derived demand for labour

2. increase in tax would reduce the take home pay and disincentivise workers form increasing hours

3. income redistribution

what curve

the laffer curve- illistrates the impact of tax rates on tax revenues, if tax goes above t* then they are disincentivised to work

impacts of government spending 5

crowding out

G is component of AD so economic growth

inflation

unemployment decreases

decrease inequality

what is an automatic stabilizer

fiscal policy instruments which act in a counter cyclical way to reduce effect of economic cycle

what are two types of automatic stabilisers

1. welfare benefits

2. income tax

how do automatic stabilisers work

in a boom there is more income tax, as people earn more. there are aslo less benefits paied out.

this reduces consumption and can ease inflation pressures of a boom. often a budget surplus.

during a ressesion. government spending rises as unemployment rises, rax revenue falls as people earn less.

this encourages consumption

4 evaluations on fiscal policy

1. time lag with governmnet spending especially capital investment

2. tax rates may have adverse incentives for firms and consumers

3. multiplier with g spending is unknown

4. ratchet effect. spending wont reduce back to levels in boom as people get acustomed to new spending levels

evaluation: crowding out

crowding out is when government spending fails to increase AD because it results in a proportional fall in private-sector spending

multiplier will be limited (no one will open owm hospital)

because i and g are in the AD formula they conflict.

kensien view on crowding out

during ressesion, private sector saves and government borrowing increases, crowding out will be limmited