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Fiscal Policy (Discretionary Fiscal Policy: Contractionary (To reduce D…
Fiscal Policy
Discretionary Fiscal Policy: Contractionary
Budget = Tax Revenue - Gov. Expenditure
Balanced, Surplus/ Contractionary, Deficit/ Expansionary
Deliberate management of gov. spending and/or taxation
To reduce D-pull inflation
Limitations
Ineffectiveness of using taxes due to good economic outlook
expect :arrow_up: future income and after-tax profits
->:arrow_up:taxes will not reduce overall disposable income, continue to spend or invest
Relative inflexibility to change gov. spending
much of gov. spending tied to long term contracts eg. construction, edu., healthcare
Unintended Consequences
of conflicting goals
direct taxes:arrow_up: has long term S-side effects on work incentive and investment, limit LRAS growth
gov. spending:arrow_down: reduces availability of essential goods&services for lower-income households
due to limitations, usually used with monetary policy
careful not to over-contract AD, otherwise hard-landing: expansion->recession
To reduce
BOT deficit
Workings
purchasing power:arrow_down:, import expenditure:arrow_down:, BOT deficit:arrow_down:
AD:arrow_down:, general price level:arrow_down:, trading partners switch to these relatively cheaper exports, D:arrow_up: and export revenue:arrow_down: + foreign goods more expensive, imports D:arrow_down: and import expenditure:arrow_down:
Limitations: Income-inelastic Imports
insignificant :arrow_down:import expenditure, if large portion of imports consists of basic necessities
Unintended Consequences: Conflicting Goals
improve trade deficit but reduce economic growth and :arrow_up:demand-deficient unemployment
Con. fiscal/ monetary for excessive spending on imports or high D-pull inflation
However, recession: use expenditure switching methods to avoid conflicting with unemployment, expenditure reducing only if high D-pull inflation
Automatic Fiscal Stabilisers
counter-cyclical forces, without deliberate gov intervention
progressive income tax, transfer payments & subsidies (unemployment benefits)
Workings
: Case of D-pull inflation: prevent AD from :arrow_up: too fast
NI:arrow_up:, tax revenue:arrow_up: automatically especially under direct progressive tax system
earn more-> gradually move into higher income tax brackets
->face higher tax rates-> dampen :arrow_up: in disposable income
transfer payments:arrow_down: with fewer claims by enemployed
->dampen:arrow_up: in NI by maintaining disposable income
Limitations
: Fiscal drag slows recovery from recession
progressive tax system: income earners pushed into higher income brackets-> more taxes & leakage
less transfer payments
Intro
Use of gov spending and/or taxation to influence level of economic activity through AD
To smooth out fluctuations associated with business cycle