Fiscal Policy - Economics Help Lecture Notes

Definition of Fiscal Policy

• Fiscal policy involves the government altering taxation and spending levels to influence Aggregate Demand (AD) and economic activity.
• Aggregate Demand (AD): Total planned expenditure (AD = C + I + G + X - M)
  • C: Consumption
  • I: Investment
  • G: Government spending
  • X: Exports
  • M: Imports

Purpose of Fiscal Policy

• Stimulate economic growth during recessions.
• Maintain low inflation (UK target: 2%).
• Stabilize economic growth, avoiding boom and bust cycles.
• Commonly used with monetary policy.

Types of Fiscal Policy

Expansionary (Loose) Fiscal Policy

• Increases AD by increasing government spending (G) and cutting taxes (T), leading to more disposable income and consumer spending (C).
• Can increase government budget deficit and necessitate borrowing.
• Diagram: Illustrates increase in AD.

Deflationary (Tight) Fiscal Policy

• Decreases AD by reducing government spending (G) and/or increasing taxes, which reduces consumer spending (C).
• Can improve government budget deficit.
• Diagram: Illustrates decrease in AD.

UK Fiscal Policy Example

• 2009: Expansionary policy during recession (GDP fell 6%); VAT cut to boost spending, resulting in increased government borrowing.
• 2010: New government imposed austerity, reduced borrowing, leading to lower growth in 2011-2012.

Fine Tuning Fiscal Policy

• Definition: Using fiscal policy to maintain steady economic growth.
  • E.g., cutting taxes to boost growth if below trend, raising taxes to slow growth if too fast.
• Challenges:
  1. Time lags.
  2. Political costs.
  3. Forecasting difficulties.

Terms Related to Fiscal Policy

• Fiscal Stance: Government's approach to AD (expansionary or tight).
• Automatic fiscal stabilisers: Natural increase in taxes and decrease in benefits during growth, opposite in recession.
• Discretionary fiscal stabilisers: Deliberate government actions to stabilize the economy.
• Primary budget deficit: Government spending minus tax receipts, excluding interest payments.
• Multiplier Effect: Increases in injections lead to a larger increase in GDP.
• Injections: Expenditure increases (G, X, I).
• Withdrawals: Income not spent (S, T, M).

Criticisms of Fiscal Policy

1. Poor economic information.
2. Time lags in implementation.
3. Crowding out private sector.
4. Inefficient government spending.
5. Higher borrowing costs.

Evaluation of Fiscal Policy

• Success depends on:
  1. Multiplier size.
  2. Economic context (e.g., effectiveness in deep recessions).
  3. Interaction with other factors (e.g., interest rates).
  4. Bond yield concerns.

Historical Context

• Keynesian Influence: Advocated fiscal stimulus during the Great Depression.
• 1950s-60s: Popular for economic stabilization.
• 1970s-80s: Shift towards monetary policy.
• 2008-13: Revival during economic crises.

US Fiscal Policy

• Noted for specific policies implemented in 2009.

Further Reading

• Explore impacts of fiscal policy and comparisons with monetary policy through provided links.

Essays on Fiscal Policy

• Topics include recovery from recessions and the impact of austerity.

Last updated: 10th July 2017, Tejvan Pettinger, www.economicshelp.org