(10) Fiscal Policy

Fiscal Policy

Changes in government spending and taxation aimed at achieving economic goals like full employment, price stability, and growth.

Expansionary Fiscal Policy

Increasing government spending or decreasing taxes to boost aggregate demand and close a recessionary gap.

Contractionary Fiscal Policy

Decreasing government spending or increasing taxes to reduce aggregate demand and control inflation.

Aggregate Demand and Fiscal Policy

When government spending rises or taxes fall, aggregate demand increases, shifting AD right. The opposite happens when spending falls or taxes rise.

Government Expenditure

The total amount the government spends, including purchases, welfare, health, and education.

Government Revenue

Mainly collected from personal income taxes and company taxes.

Government Purchases Multiplier

The ratio of change in real GDP to the change in government spending; measures how spending increases output by more than the initial amount.

Tax Multiplier

The ratio of change in real GDP to the change in taxes; smaller than the government purchases multiplier.

Multiplier Effect

The process where an initial increase in spending leads to a larger total increase in real GDP.

Crowding Out

A reduction in private spending (consumption or investment) caused by higher government spending or borrowing.

Financial Crowding Out

When government borrowing raises interest rates, discouraging private investment.

Resource Crowding Out

When government competes with the private sector for labour and resources, raising prices and reducing private output.

Budget Deficit

Occurs when government spending exceeds its tax revenue.

Budget Surplus

Occurs when government spending is less than its tax revenue.

Government Debt

The total amount owed by the government due to past deficits.

Automatic Stabilisers

Taxes and transfer payments that automatically change with the business cycle to stabilise GDP.

Discretionary Fiscal Policy

Deliberate changes in government spending or taxation to influence the economy.

Structural Budget Deficit

The deficit that would exist if the economy were operating at potential GDP; shows underlying fiscal position.

Timing Lags

The delay between identifying a problem, passing fiscal policy, and its effect on the economy.

Countercyclical Fiscal Policy

Using fiscal policy to offset business cycle fluctuations—stimulating during recessions and slowing during booms.

Supply-Side Fiscal Policy

Policies that increase long-run aggregate supply by improving incentives to work, invest, or innovate.

Tax Wedge

The difference between pre-tax and post-tax income; lowering it encourages work and investment.

Long-Run Effects of Tax Policy

Lower taxes on income, profits, or capital can shift LRAS right and boost growth.

Tax Simplification

Streamlining the tax system to reduce compliance costs and improve efficiency.

Automatic Stabiliser Example

During a recession, tax revenue falls and welfare payments rise automatically, increasing the deficit.

Debt Servicing

Interest payments on government debt; represents an opportunity cost as funds cannot be used elsewhere.

Q - When the economy is in a recession, the government can:

C) Increase spending or decrease taxes to increase AD 

Q - By how much will real GDP increase if government purchases rise by $100 billion?

A) More than $100 billion

Q - If the government increases taxes, what happens to AD?

B) Decreases 

Crowding out occurs when:

A) Government borrowing raises interest rates and reduces private investment

Q - Automatic stabilisers cause the budget to:

B) Automatically move to a deficit in recessions and surplus in booms

Supply-side fiscal policy focuses on:

B) Increasing LRAS by improving incentives to work and invest

Q - A budget deficit means:

B) Spending exceeds tax revenue

Q - Financial crowding out occurs when:

A) High interest rates discourage private investment

Which tax provides the largest share of Australian government revenue?

C) Personal income tax

Q - When the economy is close to full capacity, increased government spending may lead to:

A) Resource crowding out