14) Fiscal Policy: Effectiveness Evaluated

Question 1

what is good about fiscal policy? List 4

Answer 1

1) more direct than the alternatives
2) fiscal policy is quicker to act than the monetary or supply-side policies
3) can be used to achieve all the macro-objectives
4) works well due to automatic fiscal stabilisers

Question 2

how is fiscal policy more direct than the alternatives?

Answer 2

eg the government themselves are creating the extra AD, the extra jobs or taking money directly from certain tax payer categories.

Question 3

why is it good that fiscal policy us much more direct than alternatives?

Answer 3

the policy can be effectively targeted at the right areas of the economy, not just hoping that the other economic agents respond to indirect stimulus, as is the case with other policies

Question 4

explain how fiscal policy is much more direct than the alternatives:

Answer 4

eg the government themselves are creating the extra AD, the extra jobs or taking money directly from certain tax payer categories. This means the policy can be effectively targeted at the right areas of the economy, not just hoping that the other economic agents respond to indirect stimulus, as is the case with other policies

Question 5

why is fiscal policy quicker to act than the monetary or supply-side policies?

Answer 5

because it is much more direct

Question 6

what is an example of fiscal policy being quicker to act?

Answer 6

for example when the Covid 19 pandemic struck, the government used fiscal policy to directly and immediately tackle the crisis. Other policies may have helped over time but were not realistic in the short-term

Question 7

how can fiscal policy achieves all macroeconomic objectives? (eg expansionary fiscal policy)

Answer 7

eg expansionary fiscal policy may have a multiplier and crowding in effect, hopefully leading to economic growth and low unemployment

Question 8

how can fiscal policy achieves all macroeconomic objectives? (eg deflationary fiscal policy)

Answer 8

can help control the price level; progressive taxation can be used to ensure a fairer distribution of income; tariffs and subsidies can be used to affect the balance of payments (current account).

Question 9

can other policies be used to achieve all the macroeconomic objectives?

Answer 9

neither monetary or supply-side policies can effectively tick all of these boxes

Question 10

why does fiscal policy work well?

Answer 10

due to the automatic fiscal stabilisers. It naturally aguanta in relation to the economic cycle- eg in a boom, G will decrease and T (tax revenue) will increase

Question 11

why are there many arguments against the over-reliance on fiscal policy (4 points):

Answer 11

1) Fiscal policy relies on good, sensible, well-informed government
2) crowding out
3) disincentive effect
4) expansionary fiscal policy increasing national debt

Question 12

what are examples of government failure?

Answer 12

a) corruption
b) political priorities taking precedence over wise economic decisions
c) information failure
d) inefficient procedures

Question 13

where is corruption particularly common?

Answer 13

in developing economies but prevalent to some extent in nearly every country

Question 14

what is an example of political priorities taking precedence over wise economic decisions?

Answer 14

eg government reducing tax rates prior to an election

Question 15

what is an example of information failure?

Answer 15

government not correctly identifying the real cause or right solution to a problem

Question 16

what can cause inefficient procedures?

Answer 16

excessive bureaucracy, meaning that actions take too long to take effect or shoddy practice is accepted

Question 17

over reliance on fiscal policy can cause crowding out, explain crowding out is?

Answer 17

expansionary fiscal policy requires extensive government borrowing. this leaves a smaller pot of borrowing funds for the private sector to access, meaning that the more efficient users of funds (businesses) have less finance and the less efficient users of funds (public sector) have more

Question 18

what is the disincentive effect? (Deflationary fiscal policy)

Answer 18

Where higher tax rates (deflationary fiscal policy) can lead to workers choosing to not work, businesses moving abroad or reducing the size of their operations.

Question 19

what is the disincentive effect? (Expansionary fiscal policy)

Answer 19

Expansionary fiscal policy can lead to an over-reliance on government, eg if unemployment benefits are too generous workers might decide not to work; if governments intervene to protect businesses then business may feel in a falsely strong position compared to foreign competitors

Question 20

How does expansionary fiscal policy ultimately increase the size of the national debt? (Opportunity cost)

Answer 20

It can have a high opportunity cost - in the future governments may have to repay the debt instead of investing in schools, hospitals etc

Question 21

What is the disincentive effect? (Deflationary +Expansionary)

Answer 21

Where higher tax rates (deflationary fiscal policy) can lead to workers choosing to not work, businesses moving abroad or reducing the size of their operations. Expansionary fiscal policy can lead to an over-reliance on government, eg if unemployment benefits are too generous workers might decide not to work; if governments intervene to protect businesses then business may feel in a falsely strong position compared to foreign competitors

Question 22

How does Expansionary fiscal policy ultimately cause inflation? (Inflationary expectations)

Answer 22

Expectations of high future inflation (needed to reduce the real debt) becomes a self-fulfilling prophecy as consumers and businesses choose to spend moremoney now rather than face higher prices in the future

Question 23

When is fiscal policy the best of the three?

Answer 23

For the achievement of short-term economic objectives

Question 24

What does fiscal policies success depend on?

Answer 24

Depends on the quality of the decisions made by the government and it also very much depends on the position within the economic cycle

Question 25

What can expansionary fiscal policy cause in a recession?

Answer 25

May lead to growth without inflation, however expansionary fiscal policy near Yfe will almost certainly cause inflation but not growth