Fiscal Policy

What is Fiscal Policy?

  • Fiscal policy involves the use of government spending and taxation to influence the economy.
  • It is predominantly used to manage the level of demand in the economy and is therefore considered a demand-side policy.

Types of Fiscal Policy

  • Expansionary Fiscal Policy: Involves increasing government spending or reducing taxes to boost economic activity. Used during periods of recession or economic slowdown.
  • Contractionary Fiscal Policy: Involves reducing government spending or increasing taxes to slow down economic activity. Typically used during periods of high inflation.

Government Spending and Taxes

  • Government Spending: Governments spend money on various things such as public services, social welfare, infrastructure, education and healthcare. Increased spending can stimulate economic growth.
  • Taxes: Governments collect taxes from individuals and businesses. Higher taxes reduce disposable income which can slow economic activity. Lower taxes can stimulate economic growth by increasing disposable income.

Automatic Stabilisers

  • Automatic Stabilisers: These are fiscal tools that automatically adjust to counteract the current economic cycle without the need for government intervention.

Advantages of Fiscal Policy

  • Fiscal Policy can help stabilise the economy during volatile economic conditions.
  • It can help address issues of unemployment and inequality.
  • It provides the government with the flexibility to adapt to new economic conditions and circumstances.

Disadvantages of Fiscal Policy

  • There can be Time Lags in implementing fiscal policy. It takes time for changes in fiscal policy to affect the economy.
  • Fiscal policy can cause Deficit Spending if government spending consistently exceeds tax revenues.
  • There is a risk of Crowding Out where government spending prevents or discourages private sector activity.

Keynesian Economics and Fiscal Policy

  • In the Keynesian economic theory, fiscal policy plays a pivotal role in stabilising the economy. Keynesians argue that during periods of economic downturn, government intervention is essential to steer the economy back to full employment.

Remember, a solid understanding of fiscal policy - what it is, its types, its tools, how it works, its advantages, and its disadvantages - is crucial for mastering the “Implementing Policy” part of your Economics examination. Equipping yourself with this knowledge will set a strong foundation for success on the day of your exam.