Discretionary Fiscal Policy:
Expansionary to reduce D-pull inflation

Workings

  • People spend insufficiently, gov. spends on their behalf
  • or ⬇taxes-> ⬆purchasing power and after-tax profits-> ⬆MEI-> ⬆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-> ⬆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⬇ for SG exports ->⬆gov. expenditure too insignificant-> nullify effect

Unintended Consequences

Crowding-out Effect: ⬆gov. spending causes equivalent ⬇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⬆, 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, ⬆taxes to pay interest on debt
  • if debt⬆ 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⬇
  • pay interest-> OC
  • gov. may ⬆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⬆