Economics
Types of Fiscal Policy
Fiscal policy encompasses two main types: expansionary and contractionary. Expansionary fiscal policy involves increasing government spending and/or reducing taxes to stimulate economic growth and combat recession. On the other hand, contractionary fiscal policy involves decreasing government spending and/or increasing taxes to control inflation and cool down an overheated economy.
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Related key terms
8 Key excerpts on "Types of Fiscal Policy"
eBook - ePub- Rob Dransfield(Author)
- 2013(Publication Date)
- Routledge(Publisher)
Fiscal policy is the deliberate manipulation of government expenditure and revenues in order to achieve given policy objectives. At one level this involves the relationship between total public spending and total public revenues. For example, a deficit budget can pump extra spending into the economy whereas a budget surplus would withdraw spending from the economy. Fiscal policy also involves adjusting different types of tax and spending in order to target specific objectives. For example, the government may shift the emphasis from direct to indirect taxes or from regressive to progressive taxes.Keynesian economists believe that fiscal policies can be used by the government to stimulate the economy. In contrast neoclassical and monetarist economists believe that there should be a balanced budget.Key Ideas Fiscal policy- Fiscal policy is government policy designed to use its own spending and the taxes that it raises in order to achieve desired policy objectives such as full employment or economic growth.
- Whereas monetarists seek to balance government revenues and taxes, Keynesian economists believe that fiscal stimulus can be used to support economic growth and to counteract unemployment.
- The balance between government spending and taxes is made up by government borrowing (or paying back debt).
- The main area of government expenditure is on welfare, including health, education and social benefits.
- Government expenditure is one of the main ingredients of GDP.
- Free market supporters believe in rolling back the size of the government in the economy.
- Government spending includes central and local government spending.
- Progressive taxes take a greater percentage of income from the rich than the poor. Regressive taxes take the greatest proportion from the poor.
- Direct taxes are deducted directly from a taxpayer’s income at source. In contrast, indirect taxes are collected by a third party on behalf of the government and citizens have a choice as to whether to buy goods with indirect taxes imposed on them.
eBook - ePub- Arleen J Hoag, John H Hoag(Authors)
- 2006(Publication Date)
- WSPC(Publisher)
Fiscal policy is one form of stabilization policy. Fiscal policy involves changes in the size of government spending and tax collections. Either of these changes alters the government budget. Fiscal policy is the use of the federal budget as an economic tool to stabilize the economy. Who administers fiscal policy? Fiscal policy is administered by the president and Congress. These administrative and legislative branches of the government determine the federal budget. There are two sides to the federal budget. First is the inflow, which is tax collections. Second is the outflow, which is government spending. We conclude that fiscal policy involves the ability of the government to tax and to spend, and thus use the federal budget to affect aggregate demand, and hence GDP. How Fiscal Policy Works We saw in Chapter 23 that a change in either government spending, G, or taxation, T, changes the level of aggregate demand. Aggregate demand increases with an increase in government expenditure and falls with an increase in taxes. We now have two tools, spending and taxation, that can be applied to either unemployment or inflation. What if the economy is performing at a low level of income, and the result is unacceptable amounts of unemployment? Government could apply the appropriate adjustments to spending and taxation and increase aggregate demand, C +1 + G at each price level, to the desired amount. By raising G, C + I + G would rise and so would income, Y, since Y = C + I + G. Thus an increase in government spending increases aggregate demand, and the equilibrium level of income. Or, as an alternative to an increase in government spending, taxes could be reduced. This would leave more spending power in the hands of consumers and/or business and increase aggregate demand. Or, an increase in spending and a reduction in taxes could be combined. These are expansionary fiscal policies, intended to increase the level of income
eBook - ePubEconomics for Investment Decision Makers
Micro, Macro, and International Economics
- Christopher D. Piros, Jerald E. Pinto(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
- The concept of money neutrality is usually interpreted as meaning that money cannot influence the real economy in the long run. However, by the setting of its policy rate, a central bank hopes to influence the real economy via the policy rate’s impact on other market interest rates, asset prices, the exchange rate, and the expectations of economic agents.
- Inflation targeting is the most common monetary policy—although exchange rate targeting is also used, particularly in developing economies. Quantitative easing attempts to spur aggregate demand by drastically increasing the money supply.
- Fiscal policy involves the use of government spending and revenue raising (taxation) to impact a number of aspects of the economy: the overall level of aggregate demand in an economy and hence the level of economic activity, the distribution of income and wealth among different segments of the population, and hence ultimately the allocation of resources among different sectors and economic agents.
- The tools that governments use in implementing fiscal policy are related to the way in which they raise revenue and the different forms of expenditure. Governments usually raise money via a combination of direct and indirect taxes. Government expenditure can be current on goods and services or can take the form of capital expenditure—for example, on infrastructure projects.
- As economic growth weakens or when it is in recession, a government can enact an expansionary fiscal policy—for example, by raising expenditures without an offsetting increase in taxation. Conversely, by reducing expenditures and maintaining tax revenues, a contractionary policy might reduce economic activity. Fiscal policy can therefore play an important role in stabilizing an economy.
- Although both fiscal and monetary policy can alter aggregate demand, they work through different channels; the policies are therefore not interchangeable, and they conceivably can work against one another unless the government and central bank coordinate their objectives.
PRACTICE PROBLEMS10
1. As the reserve requirement increases, the money multiplier: A. increases.
eBook - ePub- James J. Gosling, Marc Allen Eisner(Authors)
- 2015(Publication Date)
- Routledge(Publisher)
Economic growth carries a number of benefits: increased personal income, resources for investment, new job opportunities, and enhanced citizen support for government and incumbents. Yet economic prosperity cannot be taken for granted. Workers, businesses, and elected public officials reap the benefits of growth and suffer the consequences of decline. In one sense, they are captive of the vagaries of economic cycles and fluctuations. In another sense, however, all share the conviction that government can and should act to stabilize the economy at desired levels of economic performance. Policymakers rely primarily on fiscal and monetary policy to manage the economy. This chapter addresses fiscal policy.Fiscal policy deals with the tax and spending decisions of national governments. In the United States, that means the tax and spending decisions of Congress, as affected by actions of the president. Tax and spending choices influence the national economy by affecting aggregate demand. Government taxes reduce aggregate demand because they take resources away from individuals and businesses that might otherwise be spent. Conversely, tax cuts transfer resources from the public to the private sector and increase after-tax disposable income that can be spent. Tax policy, depending on its structure, can also affect aggregate supply, to the extent that it provides strong incentives for individuals or firms to save and invest rather than spend.Government spending adds to aggregate demand through the purchases that government makes directly or through those made by the recipients of government financial assistance, whether they be individuals or other governmental units. In the latter case, states and local governments in the United States spend federal aid directly or distribute it to individuals who, in turn, spend it. In either case, this added spending increases aggregate demand. Government spending can also influence the level and potential growth of a nation’s economy, depending on the nature of that spending. Government spending on physical infrastructure, such as highways and bridges, and on education, technology development, and basic research can provide the basis for increased productivity and the higher personal income that follows.
eBook - ePubMacroeconomic Analysis and Policy
A Systematic Approach
- Joshua E Greene(Author)
- 2017(Publication Date)
- WSPC(Publisher)
Chapter 7FISCAL POLICY
Fiscal policy involves the use of the government budget to attain macroeconomic objectives. Although the overall budget balance — total revenues and grants minus total expenditures and net lending — has the greatest impact on macroeconomic activity, many specific elements of the budget, including the composition of revenues, expenditures, and financing, also have important macroeconomic implications.1. The amount of revenue and expenditure relative to the size of the economy — the ratios of revenue and expenditure to GDP — help determine the scope of the government sector in the economy. Small island economies typically have relatively high ratios of revenue to GDP, normally 35 percent or larger, because a small economy is funding a broad array of government functions. Revenue and expenditure ratios can also be high in advanced economies — above 40 percent of GDP in a number of European OECD countries, although ratios are lower in the United States, Japan, and the Republic of Korea. In many developing countries, revenue can be 15 percent of GDP or less, with expenditure a bit higher. In middle income countries, revenues average 25–30 percent of GDP, again with expenditure somewhat higher. Table 7.1 presents data for general government revenue in several groups of countries for the years 2013 through 2016, while Table 7.2 does the same for expenditure.TABLE 7.1 GENERAL GOVERNMENT REVENUE IN SELECTED GROUPS OF COUNTRIES, IN PERCENT OF GDPSource: IMF (2016), Fiscal Monitor, October 2016, Statistical Tables A5 and A13. The drop in revenue for Middle East, North Africa, and Pakistan in 2014 and 2015 reflects the plunge in world petroleum prices.TABLE 7.2 GENERAL GOVERNMENT EXPENDITURE IN SELECTED GROUPS OF COUNTRIES, IN PERCENT OF GDPSource: IMF (2016), Fiscal Monitor, October 2016, Statistical Tables A6 and A14.2. The composition of revenues can affect the economy’s productivity, because taxing income imposes a “double taxation” of savings (savings come from after-tax income, while the earnings from savings — interest, dividends, and capital gains — are also taxed) unless income from capital is tax-exempt, as in Singapore. Relying more on consumption taxes, such as value-added and sales taxes, avoids this problem, although consumption taxes typically fall more heavily on low- and middle-income households, which generally save less of their incomes than the rich. Complex revenue systems, with many exemptions and exclusions, can distort behavior, driving taxpayers into less-efficient but tax-sheltered investments and shifting purchases from high-tax to low-tax or tax-exempt goods and services.
eBook - ePub- Hal W. Snarr(Author)
- 2014(Publication Date)
- Business Expert Press(Publisher)
CHAPTER 5 Fiscal PolicyDiscretionary fiscal policy is the deliberate change in government expenditure or tax rates to affect changes to real GDP and unemployment. It was deemed ineffective in the aggregate market model but not in the AE model. The disagreement arises from how the models treat the PL. In the aggregate market model shown in Figure 5.1a , SRAS slopes up. When expansionary fiscal policy is adopted, the PL rises as AD shifts up along SRAS. The higher PL dampens fiscal policy’s expansionary effect on real GDP. In the AE model, the PL is held constant when analyzing the effects of expansionary fiscal policy. This assumption is carried over to the aggregate market model shown in Figure 5.1b by assuming that SRAS is perfectly elastic.The slope of SRAS splits macroeconomics into two major schools of thought: the long-run model of classical economics shown in Figure 5.1a and the short-run Keynesian model shown in Figure 5.1b . In the classical model, SRAS slopes up, intersects AD at LRAS due to resource markets clearing over the long run, and is shown in gray to stress the triviality of the short run. In Keynesian economics, prices and wages are assumed to be rigid in the short run. This makes SRAS elastic, inhibits resource markets from clearing, and makes recessionary gaps persistent. Stubbornly high unemployment in a recessionary gap or rising prices in an inflationary gap beckon elected officials and the Fed to alleviate these short-run hardships with fiscal policy. The emphasis the Keynesian school of economics places on closing short-run output gaps is why the LRAS is shown in gray in Figure 5.1b
eBook - ePubFiscal and Monetary Policy in the Eurozone
Theoretical Concepts and Empirical Evidence
- Rosaria Rita Canale, Rajmund Mirdala(Authors)
- 2019(Publication Date)
- Emerald Publishing Limited(Publisher)
Chapter 2
Fiscal Policy in the Eurozone
Abstract
This chapter is devoted to fiscal policy theory and to how its evolution influenced the policy principles implemented from the end of the World War II to the present. It shows how the theoretical foundations evolved, from the Keynesian theory according to which public expenditure was conceived as an instrument to sustain aggregate demand and achieve full employment, to the present theoretical framework in which, following the intertemporal approach, it has been downgraded to an external shock. The public debt issue is examined with the aim of explaining why sound public finance represents a primary policy objective in the Eurozone.Keywords: Fiscal policy; Keynesian approach; intertemporal approach; public finance; public debt; Eurozone2.1. From Keynesian Macroeconomics to Contemporary Theory
The theory defining the level and the components of the national gross domestic product that can be found in basic macroeconomics texts, has Keynesian economic theory as its starting point. From the publication of the General Theory (1936) – Keynes’ main work – and up to the 1970s, the majority of economists referred to Keynesian economic theory to interpret the economic system of the time. Despite numerous differences in the perspective and emphasis assigned to some specific issues, scholars shared a common view based on the main core. This core can be divided into two essential points that will be explained more fully in the course of the discussion:- (1) aggregate demand plays a major role in defining the equilibrium income; and
- (2) economists should focus on the short run: the external shocks that occur with the passing of time cannot be predicted. Furthermore, short-run equilibria will define long-run equilibria.
These two features of Keynesian thought have, as their analytical foundation, the consumption function and the analysis of the “sole” monetary dimension of the variables. The consumption function makes it possible to question the theory of determination of national income following a simple accounting perspective according to which GDP is defined through the sum of its single components. Using the distinction between ex ante and ex post, or the distinction between spending decisions and the equilibrium that such expenditure sets out to achieve, the effects of the initial expenditure on the level of GDP at the end of the period can be measured with the introduction of the consumption function based on current income. Furthermore, the emphasis laid on the monetary dimension – rendered with a simplification with the artifice of constant prices – makes it possible to focus on the fact that what is of interest for economic agents is the amount of expenditure at the current time. These two analytical features shaped the great success of the massive interventions of fiscal policy together with accommodating monetary policies to sustain the value of expected demand and hence the level of employment.
eBook - ePubMarkets for Managers
A Managerial Economics Primer
- Anthony J. Evans(Author)
- 2014(Publication Date)
- Wiley(Publisher)
Essentially this means that governments may choose to focus on prioritising the confidence of the bond markets, rather than the confidence of domestic consumers and businesses. Having said this, it's rarely a case of one or the other. It may be that the public are as concerned by the amount of borrowing (i.e. deferred taxation) as the bond markets are. Journalists like to pretend that ‘the markets’ are separate from the public, but financial institutions are just intermediaries. In many cases it is the public who own the pension pots that have invested in government debt. What it comes down to is how people react, and we can't know this based on theory.In the same way that there are pros and cons to a fiscal stimulus, we should also look at the alternative – a fiscal contraction. The question is, under what circumstances is it conceivable that a reduction in government deficits stimulates growth?The first problem is defining the fiscal stance. There are typically two ways that economists do this. One focuses on the effects of the policy. In other words we can define a fiscal contraction as when the cyclically adjusted primary budget deficit falls by at least 1.5% of GDP. The alternative is to focus on the intentions, and just choose some absolute level independent of external shocks that may also affect the economy.According to Alberto Alesina, ‘not all fiscal adjustments cause recessions. Countries that have made spending adjustments to reduce their deficits have made large, credible and decisive cuts. Even in the very short run, many reductions of budget deficits, even sharp ones, have been followed immediately by sustained growth rather than recessions.’44 There are examples of expansionary fiscal contractions, even in the short run:45- In 1981 the UK was in recession and 364 economists wrote to Margaret Thatcher warning her not to cut government spending. She did so anyway, and the recovery began that very quarter.46
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