DISCRETIONARY FISCAL POLICY (Contrationary Fiscal Policy (To solve demand…
DISCRETIONARY FISCAL POLICY
The deliberate management of government spending and taxation to influence the level of economic activity, inflation and economic growth of the country.
Expansionary Fiscal Policy
To solve negative or slow economic growth and cyclical unemployment
Small multiplier due to high marginal propensity to withdraw. Thus national income may not increase as much.
Relatively small amount of government spending to other components of AD will reduce effectiveness.
External conditions such as a trade partner's economic situation may nullify fiscal policy during a worldwide recession.
The government increases its budgetary spending and reduces taxes during recession.
With a fall in income tax, purchasing power and consumption level will increase. With a fall in corporate tax, expected profits and thus investment level increases.
A rise in government expenditure increases aggregate expenditure, leading to an unplanned decrease in stocks.
Firms hire more factors of production such as labour to increase output.
Aggregate demand, employment level and national income increases by the multiplier effect.
Contrationary Fiscal Policy
To solve demand-pull inflation
The government decreases its budgetary spending and increases taxes during an economic boom and times of high inflation.
With a rise in income tax, purchasing power and consumption level will decrease. With a rise in corporate tax, expected profits and thus investment level will decrease.
Fall in government expenditure decreases aggregate expenditure, leading to an unplanned increase in stocks.
Firms hire fewer factors of production such as labour to decrease output.
Aggregate demand falls, bringing down the general price level.
Relative inflexibility to changes in government spending as government expenditure is usually tied to long-term contracts.
Taxes may be ineffective due to good economic outlooks
Raising taxes may have long-term supply-side effects that may reduce LRAS
To solve BoT deficit
Imports may be income-inelastic in demand if it comprises only basic necessities.
Conflict of macroeconomic goals, as this results in demand-deficient unemployment.
The government decreases its budgetary spending and increases taxes. This is an expenditure-reducing method to curb BoT deficit.
When national income falls, purchasing power falls. This reduces import expenditure..
The low inflation rate due to the reduction in GPL leads to relatively lower export prices and increases export competitiveness. Assuming PED>1 for exports, this results in a more than proportionate rise in exports.
With a rise in export revenue and fall in import expenditure, net export revenue increases and BoT improves