Fiscal policy

Question 1

What is fiscal policy

Answer 1

Decisions by government on government spending or taxation

Question 2

What effect does expansionary fiscal policy have?

Answer 2

Increased government spending & less taxation:

• Increases AD (C+I+G)
• AD increases - reduction in unemployment
• Demand-pull inflation

Question 3

What effect does fiscal policy have on AS?

Answer 3

E.g. Increased govt. spending on education may improve skills and qualifications of workforce - improves quality of labour - more productive - increases capacity so LRAS increases

• Less corp tax - more investment - better capital - improves quality and quantitiy of capital - capacity increases

Question 4

Pros and cons?

Answer 4

Pros:

• can affect C+I+G
• Can affect both AD and AS

Cons

• Demand-pull inflationary pressure (expansionary policy)
• Time lag - e.g. corporation tax change announced in 2016 budget wont be in effect till 2020 (17%)
• Disincentive effects ( increase in income tax can reduce incentive to work - leads to unemployment - reduced workforce cal lower LRAS
• Financing policy can lead to greater budget deficit - burden on future generations as they may face higher taxes - its not sustainable

Question 5

Evaluation of fiscal policy

Answer 5

Depends on:

• Initial level of economic activity (if near capacity it may not increase GDP)
• Length of time lag
• If offset by other factors (e.g. high interest rates may affect outcome of contractionary fiscal policy)