Fiscal policy Flashcards
what is a deflationary gap?
The amount by which actual aggregate demand falls short of aggregate supply at the level of full employment
What is an inflationary gap?
The amount by which an actual aggregate demand exceeds aggregate supply at the level of full employment
What is a fiscal policy?
The use of government revenue collection (mainly taxes) and expenditure (spending) to influence the level of economic activity
What is a government budget?
An annual financial statement presenting the government’s proposed revenues and spending for a financial year that is often passed by the
legislature, approved by the chief executive or
president and presented by the Finance Minister
to the nation.
3 main sources of government revenue
- Direct and indirect taxes
Direct (e.g., income and company taxes) and indirect (e.g., sales, VAT, and excise taxes) taxes are typically the largest source of government revenue. - Sales of goods and services
from state-owned enterprises (e.g., postal services and vehicle licensing) and the fees charged by other government departments (e.g., issuing building consents and passports). - The sale of state-owned (government-owned)
enterprises
the sale of which generates a one-off
payment to the government.
Such sales are termed privatisation and are a transfer
of ownership from the government to the new private
sector owners.
3 main government expenditures
- Current expenditures
is expenditure on goods and services consumed within the current year, such as health and educational services. - Capital expenditures
This is money spent by the government on acquiring or maintaining fixed assets, such as land, buildings, and
equipment. - Transfer payments
Transfer payments include payments by the government to vulnerable groups for the purposes of
income redistribution (for example, unemployment
benefits, child allowances, pension etc.).
Goals of fiscal policy
- low and stable inflation
- low unemployment
- promote a stable economic environment for long term growth
- reduce business cycle fluctuations
- equitable distributions of income
- external balance
Expansionary fiscal policy
occurs when government taxation and expenditure is adjusted in the form of tax cuts, increased transfer payments and increased government spending.
CONTRACTIONARY FISCAL POLICY
decreased government spending
increase in the rates of income taxes and business taxes
Limitations of fiscal policy: time lags
- Changes to fiscal policies take time to plan, get approval and execute before there are any impacts on the economy.
Tax laws take time to legislate and administer. A small cut in income tax, for example, is likely to take some time before households adjust their spending habits and consumption levels.
Limitations of fiscal policy: political pressures
- Government spending and taxation policies are often influenced by political rather than economic factors.
●Large tax cuts may help to gain political votes
rather than tackling fundamental economic problems such as price instability or declining international competitiveness due to rising inflation in the domestic economy.
Limitations of fiscal policy: in recession
In a recession, tax cuts may not be very effective in increasing aggregate demand
●Tax cuts are less effective in a recession than increases in government spending because part of the increase in after tax income is saved.
●If the proportion of income saved rises due to pessimism about the future, the impacts of tax cuts on aggregate demand are even weaker.
●Increases in government spending are more powerful
because they work in their entirety to increase aggregate demand.
Advantages of fiscal policy: Targeting of specific economic sectors
Whereas monetary policy is indiscriminate, fiscal policy can be used to target specific sectors of the economy.
●This can be due to regional disparities in income and
spending habits, or due to wage differentials between
individuals and households.
Advantages of fiscal policy: Government spending effective in deep recession
An injection of government spending means that economic activity increases in order to tackle a recession, even if this means having to run a budget deficit.
●Expansionary fiscal policy can also help to increase
both consumer and business confidence levels during
a recession.
FISCAL POLICY AND Long run GROWTH
Fiscal policy can be used to promote long-term economic growth (increases in potential output)
●indirectly by creating an economic environment that is favourable to private investment,
●and directly through government spending on physical capital goods and human capital formation, as well as the provision of incentives for firms to invest.
● Although fiscal policy is essentially focussed on the short-term stabilisation of economic activity, it can also promote long-term economic growth
