Lecture 4.1: Fiscal Policy

Question 1

What is Fiscal Policy?

Just definition.

Answer 1

Governemtn decisiosn to spend, raise revenue and issue debt.

Question 2

Fiscal policy spending explained

Answer 2

Gov purchases of G/S’s e.g. military, transfer payments, interest payments to gov debt holders

Question 3

Fiscal policy revenue explained

Answer 3

Personal and company tax

Question 4

Practical limitations of fiscal policy

Answer 4

• Lags in making and implementing decisions
• Lags between decisions and effect
• Tension between timing and most worthwhile spending e.g. infastructure
• Waste

Question 5

Side effect limitations of fiscal policy

Answer 5

• Changes in taxes may distort incentives to work and invest e.g. people can earn the same income working less hourse (as less is taken out in the form of tax)
• Financing a deficit may push up interest rates through expenditure which may in turn ‘crowd out’ private investment

Question 6

Types of Fiscal Policy changes

Answer 6

1. Discretionary - one-off intentional transfer payments e.g. infastructure
2. Non-discretionary (automatic stabilisers) - in a contraction the increased unemployment will automatically increase the value of gov welfare and gov revenue will decrease (taxes decreases)

Question 7

Gov budget constraint formula

Answer 7

Gt + iB(t) (Interest payments) + Transfers(t) = Taxes(t) + (B(t+1)-B(t))
* (B(t+1)-B(t)) is the deficit or surplus

Question 8

Problems with fiscal policy

Answer 8

1. Controls inflation at the cost of contracting output (Y)
2. Takes a long time to impact the economy (weeks-months) making it very easy to get the timing wrong.