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.