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Discretionary Fiscal Policy: Expansionary to reduce D-pull inflation…
Discretionary Fiscal Policy:
Expansionary to reduce D-pull inflation
Workings
People spend insufficiently, gov. spends on their behalf
or :arrow_down:taxes-> :arrow_up:purchasing power and after-tax profits-> :arrow_up:MEI-> :arrow_up:I&C
Direct tax rate usually not changed for short term purpose since difficult to raise in future due to unpopularity-> loss in votes
Usually give tax holidays/exemption/rebates
Limitations
Size of Multiplier
high income tax rate, savings rate, heavy import dependence-> high propensity to withdraw-> small multiplier
Small for SG: import raw materials & basic necessities, much of wealth 'locked up' in CPF(mandatory savings)
Proportion of Gov. Spending in AD
SG: export revenue > 20 times gov. spending
Small-> :arrow_up:gov. expenditure >proportionately to offset fall in AD
Limitations of Tax Cuts
C&I also depend on future expected income and business confidence, may view attempts as temporary measures
Time Lags
between identification of problem and time when measures take effect
Take effect at wrong time-> destabilizing eg. reduce cyclical unemployment only after recovery-> overheated
Relative Inflexibility
Budgets usually drawn up annually, parliamentary debates and approval can take months
Tax changes implemented more quickly but weaker multiplier as some disposable income saved from tax cut
External Conditions
Eg. other countries in recession, D:arrow_down: for SG exports ->:arrow_up:gov. expenditure too insignificant-> nullify effect
Unintended Consequences
Crowding-out Effect
: :arrow_up:gov. spending causes equivalent :arrow_down:private sector spending
Gov. sells bonds, offering higher interest rates to get funds to spend ->private companies then raise interest rates to attract funds
Gov. borrows from banks
->less funds in banks ->lower credit creation ->interest rate:arrow_up:, discourage private investment (assuming fixed S of money)
High
National Debt
Gov. borrows to spend on items that add to NI, borrowing creates extra taxes that can pay interest
if do not add to NI, :arrow_up:taxes to pay interest on debt
if debt:arrow_up: rapidly and interest payments take up even larger proportion of NI -> ever-increasing tax burden
if public loses confidence in gov.'s ability to repay debt-> sells bonds-> bonds P:arrow_down:
pay interest-> OC
gov. may :arrow_up:taxes after recovery to pay interest
Fiscal policy still used as it boosts confidence by signalling that gov. trying to resuscitate economy
-> crowding-in effect, autonomous I&C:arrow_up: