AS Macroeconomics: Fiscal Policy and its effectiveness

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AS Macroeconomics: Fiscal policy and the effectiveness of fiscal policy
Fiscal policy: the taxation and spending decisions of a government.
Key aim ­ influence aggregate demand (AD)
Government spending is a component of AD
Tax ­ e.g. income tax, VAT
Income tax ­ direct tax and a progressive tax
Progressive tax: a tax that takes a higher percentage of income from the rich.
Cut in income tax ­ increases disposable income - people have more money to spend on goods
and services ­ increases consumption (C) ­ increases AD.
Lower corporation tax ­ higher `post tax' profits for firms ­ increases the ability and
willingness of firms to invest ­ increases investment (I) ­ increases AD.
VAT ­ indirect and a regressive tax
Regressive tax: a tax that takes a higher percentage of income from the poor.
VAT is imposed on the sale of goods and services at different rates. Standard rate ­ 17.5%
Cut in indirect tax (e.g. VAT) ­ lower prices, higher real disposable income ­ increases
consumption (C) ­ increases AD.
Government spending
Five most important areas of government spending: Social protection, Health, Education,
Defence, Debt interest. Government spending (public spending) can be divided into:
Capital expenditure ­ on, for example, hospitals, schools, roads.
Current spending ­ on the running of public services and including, for example,
teachers' pay, and the purchase of medicines to be used in the NHS.
Transfer payments ­ money transferred from tax payments to recipients of benefits,
for example pensioners and the unemployed.
Debt interest payments ­ payments made to the holders of government debt, for
example, interest paid to holders of National Savings certificates.
Different types of fiscal policy
Rises in government spending and cuts in tax designed to increase AD are referred to as
reflationary, expansionary or loose fiscal policy.
Deflationary, contractionary or tight fiscal policy involves measures that reduce AD ­ cuts
in government spending, rises in taxes.

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Economic stability and fiscal policy
Government can use discretionary fiscal policy or allow automatic stabilisers to operate.
Discretionary fiscal policy used when a government actively influences AD by changing
expenditure or tax.
Automatic stabilisers: forms of government spending and taxation that change automatically
to offset fluctuations in economic activity without any deliberate changes in government policy.
Advantages of fiscal policy
Changes in government spending DIRECTLY affect (G) component of AD.
Changes in tax affect (C) and (I) components of AD.…read more

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consumption, as this affects the size of the multiplier effect ­ low multiplier effect ­ lower
impact on AD.
S ­ Sustainability of government spending ­ creates a hole in government
finances, forced to borrow ­ this accrues interest for the gov, unlikely that they'll be able to
follow expansionary fiscal policy indefinitely.…read more



A 2 page summary of fiscal policy. It lacks diagrams and analysis but good for criticisms of fiscal policy.

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