Types of Fiscal Policy
Fiscal policy is used to achieve government objectives using taxation, public spending and the budget deficit/surplus:
- Keynesian fiscal policy - demand-side fiscal policy uses increases in govt. spending and decrease in taxation to boost AD. Increase in govt. spending is an injection into the circular flow of income
- Discretionary fiscal policy - When fiscal policy is used to raise/lower taxes and government spending in otder to manage AD and maintain a high level of employment and avoid an increase in the rate of inflation
- Supply side fiscal policy - Tax cuts to increase incentives to work harder and increase LRAS through risk-taking and investment
1 of 4
Effects of expansionary fiscal policy
- Increase in government spending/decrease in taxation is an injection into the circular flow of income, this causes AD to increase
- Eliminates cyclical demand if the economy is in recession or negative output gap
- Could cause demand pull inflation depending on how close the economy is operating to YFE
- Inflationary if close to YFE and AD increases, reflationary if far from YFE and AD increases
- Expansionary fiscal policy effects are short-lived and main effect is inflation
- Government spending multiplier - e.g. if increase in govt. spending is £10bn, the resulting increase in nominal national income is £40bn if the size of the multiplier is 4.
- Most real output is produced by the private sector
- Could result in crowding out - when government spending grows at the expense of private sector spending but there is no overall increase in output.
2 of 4
Effects of taxation
- Reduces the amount of income that people have available to spend on consumption/imports (disposable income)
- Alters the relative price of goods and services
- Finances government spending
- Progressive taxation helps distribution of wealth and income by taxing the rich and distributing to the poor through welfare benefits
- Supply siders argue that taxation reduces incentives to work and be entrepreneurial and increases incentives to live off benefits. (Laffer curve?)
3 of 4
Recent fiscal policy
- Main areas of UK govt spending in 2013 were: welfare and pensions (social ‘protection’), health, education, public order and safety, and defence.
- The new coalition government after the recession, dominated by the conservatives, favoured a return to supply side fiscal policy.
- Taxes were raised and govt. spending was severely cut, and fiscal austerity replaced the fiscal stimulus.
4 of 4