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Fiscal Policy Mind Map Minor - Coggle Diagram

- - - - Capital Expenditures = Long-term government investments to increase an economy’s productive capacity. For example, investments in infrastructure.
      - Transfer Payments = Welfare payments without a corresponding return. For example, unemployment benefits, pensions, child allowances, etc.
      - Current Expenditures = Spending on goods and services consumed within the current year. For example, wages/salaries of government employees.
    - - Balanced Budget: When government expenditures and government (tax) revenues are equal usually over a period of year.
      - Budget Deficit: When government expenditures exceed government (tax) revenues usually over a period of a year. This may happen during a recession when taxes are low & transfer payments are high. Budget deficits require government borrowing & they increase the “public debt” (= an accumulation of budget deficits). It is most likely expensive due to interest charges on loans.
      - Budget Surplus: When government (tax) revenues exceed government expenditures usually over a period of a year. This may happen during booms when taxes are high & transfer payments are low. Budget surpluses will decrease the public debt caused by budget deficits in previous years but they can be unpopular among taxpayers.
    - - Sale of government-owned (state-owned) enterprises
        
        It is the sale of government earned or state earned enterprises. Sometimes governments decide to sell businesses that have traditionally been earned by the government to the private sector; this is a process known as privatization.
      - Sale of goods and services
        
        Like providing postal services or nationwide railway operators. Governments themselves sell goods and services and so the money they receive from selling goods and services is part of the government revenue.
      - Taxes
        
        Direct = All taxes on the income of the factors of production and wealth.
        Indirect = All taxes on expenditure on goods and services.
- - - - Fluctuations in the business cycle are caused by the forces of aggregate supply and aggregate demand, such as the movement of the gross domestic product GDP, the availability of capital, and expectations about the future. The cycle is generally separated into four distinct segments, recovery (expansion), boom, recession (contraction), and trough.
    - - Expansionary Fiscal Policy (during a recession) → The goal of expansionary fiscal policy is to manage output and employment through increasing government spending and decreasing taxation.
      - Contractionary Fiscal Policy (during a boom) → The goal of contractionary fiscal policy is to manage output and inflation through decreasing government spending and increasing taxation.
      - Automatic stabilizers (during both a recession and a boom) → Institutionally built-in features (like unemployment benefits and progressive income taxation) that tend to decrease the short-term fluctuations of the business cycle without the need for governments to intervene. (same RWE as Expansionary Fiscal Policy)
    - - (EFP) Lowers taxes → When the economy is recessioning, governments may make use of expansionary fiscal policy in order to lower taxes. Lower levels of taxation lead to higher levels of disposable income and an increase in consumption. An increase in consumption results in higher aggregate demand and higher gross domestic product (GDP). Firms will respond to an increase in demand and higher GDP by increasing production, which requires more workers. Therefore, there will be less cyclical unemployment. Additionally, when there is strong economic growth and higher aggregate demand, there are fewer job losses, because companies remain in business.
      - (EFP) Increases Government Spending → Increasing government spending is effective during periods of deep recession. This is because governments are able target specific economic sectors such as education and training, in order to improve skills and education by increasing labor productivity and thus enabling higher long-term economic growth, infrastructure investment, in order to enhance roads and railways which can help remove supply bottlenecks and enable greater efficiency as well as boost long-term economic growth, and an increase in welfare benefits, in order to help reduce levels of inequality, for example, benefits to the unemployed enable them to maintain a minimum income and avoid absolute poverty.
      - (CFP) Reduces government debt → When the economy is booming, governments may make use of contractionary fiscal policy in order to reduce the government’s budget deficit and the national debt, saving money for future times when expansionary policy may be necessary.
      - (AS) Promotes Equitable Distribution of Income/Regulation of Income Taxes → Automatic stabilizers can include the use of a progressive taxation structure under which the share of income that is taken in taxes is higher when incomes are high. The amount then falls when incomes fall due to a recession, job losses, or failing investments. For example, as an individual taxpayer earns higher wages, their additional income may be subjected to higher tax rates based on the current tiered structure. If wages fall, the individual will remain in the lower tax tiers as dictated by their earned income.
      - (CFP) Paces economic growth → To ensure a slow, steady pace through the business cycle (a term in Keynesian economics for the natural boom-bust economic rhythm), governments can enact contractionary fiscal policy to maintain the aggregate demand curve, reduce citizens’ disposable income, and continue a healthy economic growth rate at 3 percent.
      - (AS) Provides Unemployment Benefits → Similarly, unemployment insurance transfer payments decline when the economy is in an expansionary phase since there are fewer unemployed people filing claims. Unemployment payments rise when the economy is mired in recession and unemployment is high. When a person becomes unemployed in a manner that makes them eligible for unemployment insurance, they need only file to claim the benefit. The amount of benefit offered is governed by various state and national regulations and standards, requiring no intervention by larger government entities beyond application processing.
    - - (EFP) Effect on net exports (previously mentioned)
      - (EFP) Crowding out effect (previously mentioned)
      - (EFP) Sustainable debt (previously mentioned)
      - (CFP & EFP) Inability to achieve specific targets (previously mentioned)
      - (CFP) Political Pressures (previously mentioned)
      - (AS) Problems with Fixing Inflation → A limitation of the automatic stabilization policy is that it doesn't work if inflation is caused by factors other than those affecting aggregate demand.
      - (CFP & EFP) Time Lags (previously mentioned)
      - (AS) Not Possible in Developing Countries → Additionally, automatic stabilizers are not an option in less-developed countries as the country must have a well-developed tax and social welfare system in place. Furthermore, they may have an exaggerated effect on government finances. For instance, government borrowing during times of recession increases, which in turn limits the funds available to the private sector for research, investments and other factors that would otherwise stimulate economic growth. Whenever government expenditure increases, the money has to come from somewhere.
  - - - Fiscal Policies → A demand-side policy using changes in government spending and/or direct taxation to influence aggregate demand and thus growth, employment and prices. Fiscal Policies such as Expansionary and Contractionary may be used (more information has been previously mentioned)
      - Interventionist Supply Side Policies → A set of policies that aim to increase an economy’s productive capacity that relies on a greater role for the government; these include expenditures on infrastructure, education, health care, research and development, and all industrial policies.
    - - Improves the Productivity of Factors → Measures to improve factor productivity, which is the marginal output generated by factors inputs, include the following: Decreased Taxes, The Removal of Restrictive Practices and Labor Market Rigidities, Improve Labor Mobility, Improve Education, The Adoption of Performance-Related Pay, and The Encouragement of Local rather than Central Pay Bargaining.
      - Reduce Inflation → Supply-side policies can help reduce inflationary pressure in the long term because of efficiency and productivity gains in the product and labor markets.
      - Improves the Performance of Firms → Measures to improve competition and efficiency in product markets, especially in global markets, are also a significant part of supply-side policy. For example, Subsidies and Decreased Taxes, Deregulation, Privatization, and The Presence of Small Businesses.
      - Improve Unemployment → They can also help create real jobs and sustainable growth through their positive effect on labor productivity and competitiveness. Increases in competitiveness will also help improve the balance of payments.
      - Benefits of both Expansionary and Contractionary have been previously mentioned.
      - Avoidant of Conflicts → Finally, supply-side policy is less likely to create conflicts between the main objectives of stable prices, sustainable growth, full employment and a balance of payments. This partly explains the popularity of supply-side policies over the last 25 years.
    - - Cause of an unstable economic environment can originate from both the aggregate demand and aggregate supply side of an economy.
        
        Stock market crashes (e.g. 1929 Stock market crash)
        
        Black swan events (e.g. major natural disaster, coronavirus outbreak 2020)
        
        Change in confidence levels (e.g. worries after 9/11)
        
        Labor market unrest (e.g. The Winter of discontent in the 1970s)
        
        Changing interest rates (rise in interest rates around 2005-07)
        
        Erratic leadership (e.g. Trump’s trade war with China)
        
        Changing commodity prices (especially oil, e.g. 1974 oil price shock)
    - - Time Lags → However, supply-side policy can take a long time to work its way through the economy. For example, improving the quality of human capital, through education and training, is unlikely to yield quick results. The benefits of deregulation can only be seen after new firms have entered the market, and this may also take a long time.
      - Costly → In addition, supply-side policy is very costly to implement. For example, the provision of education and training is highly labor intensive and extremely costly, certainly in comparison with changes in interest rates.
      - Drawbacks of both Expansionary and Contractionary have also been previously mentioned.
      - Political Pressures → Furthermore, some specific types of supply-side policy may be strongly resisted as they may reduce the power of various interest groups. For example, in product markets, profits may suffer as a result of competition policy, and in labor markets the interests of trade unions may be threatened by labor market reforms.
      - Issue of Equity → Finally, there is the issue of equity. Many supply-side measures have a negative effect on the distribution of income, at least in the short-term. For example, lower taxes rates, reduced union power, and privatization have all contributed to a widening of the gap between rich and poor.
  - - - Expansionary fiscal policy → The goal of expansionary fiscal policy is to manage output and employment through increasing government spending and decreasing taxation.
    - - Lowers taxes → Lower levels of taxation lead to higher levels of disposable income and an increase in consumption. An increase in consumption results in higher aggregate demand and higher gross domestic product (GDP). Firms will respond to an increase in demand and higher GDP by increasing production, which requires more workers. Therefore, there will be less cyclical unemployment. Additionally, when there is strong economic growth and higher aggregate demand, there are fewer job losses, because companies remain in business.
    - - Structural unemployment → A kind of long-term unemployment that arises from a number of factors including: technological change; changes in the patterns of demand for different labor skills; changes in the geographical location of industries; labor market rigidities.
      - Frictional unemployment → Unemployment of individuals who are in-between jobs, as people quit to find a better job or to move to a different location.
      - Cyclical (demand-deficient) unemployment → Unemployment that is a result of a decrease in aggregate demand and thus of economic activity; it occurs in a recession.
      - Seasonal unemployment → Unemployment that arises when people are out of work because their usual job is out of season, for example, agricultural workers during winter months.
    - - Sustainable debt → Governments may have to run budget deficits in order to fund expansionary fiscal policies and, over time, this may accumulate into unsustainable national debt in the long run. Because of this, governments may not fund necessary public speaking.
      - Effect on net exports → Expansionary fiscal policy, especially increased government borrowing and spending, may lead to an increase in interest rates. This may lead to an increase in the exchange rate, making exports less attractive and imports more attractive. This in turn may lead to a fall in (X-M), which will work against the desired outcome of expansion.
      - Time Lags (previously mentioned)
      - Crowding out effect → If governments attempt to increase spending through increased borrowing, they then monopolize funds available in the economy for borrowing. This means that firms may not have access to funds for investment and so investment will fall. AD will not shift as much, since the increase in government spending (G) will be partially, or completely, offset by a fall in investment (I). The increased demand for borrowing by the government will also increase the interest rate and thus will have contractionary monetary effects.
      - Inability to achieve specific targets (previously mentioned)
  - - - The Role of Different Taxation Systems → Taxes are mandatory contributions levied on individuals or corporations by a government entity. (Extra: Direct Taxes → All taxes on the income of the factors of production (wages, interest, profit, rent) and wealth (may be used as a mechanism to redistribute income and thus to promote equity) AND Indirect Taxes → All taxes on expenditure on goods and services (sales tax, VAT, excise duties)
    - - Proportional Taxes → A system of taxation where tax is levied at a constant rate as income rises. Therefore, regardless of level of income the tax rate is fixed/constant, i.e: the % taken in taxes is fixed thereby creating a flat tax rate.
      - *It is important to note that while progressive and proportional taxation systems may help in redistributing income, they also have the possibility of creating “disincentives” to work hard & harm efficiency & economic growth.
      - Progressive Taxes → Taxation where the fraction of tax paid increases as income increases. The average tax rate increases. It is a very common way to redistribute income from higher-income earners to lower-income earners. As income rises, a higher proportion (%) is paid in taxes.
    - - There are many causes that go into the creation and distribution of wealth and income in the world such as government policies, technological change, trade globalization, financial globalization, financial deepening, changes in labor market institutions, redistributive policies, education levels and economic markets.
        
        For instance, markets may result in a very wide distribution of income, such that some individuals may receive no income at all. Incomes are earned in a market when individuals sell or hire out their factor of production to others, which include wages, interest, profit and rent. However, these incomes can vary considerably, and some individuals cannot earn even a moderate income. In a free market it may be difficult for some individuals to earn an income at all, leaving them unable to buy goods and services. Those who are likely to receive less than ‘average incomes’ include: the unemployed, the underemployed, the sick and disabled, those with poor qualifications or low skills, the elderly and those working in the unofficial labor market where pay is below the legal minimum.
    - - Regressive Taxes → Taxation where the fraction of tax paid decreases as income increases. The average tax rate decreases. All indirect taxes are regressive. As income increases the % paid in taxes decreases. Therefore taxes fall on heavier low-income earners, for example, VAT, GST, sales taxes, excise duties, etc.
      - Disincentives to Work → It may create a disincentive effect, which occurs when individuals are discouraged from working hard, because they pay more taxes.
      - Creation of Moral Hazard → It may create moral hazard, where some individuals may not make an effort to find ways to improve their own position because the state provides insurance against poverty, unemployment and disability.
  - - - Contractionary Fiscal Policy → The goal of contractionary fiscal policy is to manage output and inflation through decreasing government spending and increasing taxation.
    - - Slows down inflation → To slow inflation, governments may enact contractionary fiscal policy in order to decrease aggregate demand, which will lead to decreased output and lower price levels.
    - - Cost-push inflation → Inflation that is a result of increased production costs (typically because of rising money wages or rising commodity prices) and illustrated by a leftward shift of the SRAS curve.
      - Demand-pull inflation → Inflation that is caused by increases in aggregate demand.
    - - Political Pressures → Government spending and taxation are often influenced by political factors, rather than economic factors. For example, deflationary fiscal policies may be needed, but they may be blocked by political parties who do not want to raise taxes for fear of losing votes.
      - Inability to achieve specific targets → It is very difficult, if not impossible, to finely adjust fiscal policy to achieve specific targets. The government expenditure and tax changes are large and affect many different areas of the economy. It is possible to get the economy moving in the desired direction, expanding or contracting, but it is difficult to predict the precise outcome.
      - Time Lags → Changing fiscal policy takes time. Tax rates cannot be changed quickly. In most countries, changes to the tax structure will need to go through the democratic processes governing the country and it will take time to gain approval. This will slow down the implementation of fiscal policy. Also, once the fiscal changes have been made, even when successful, it is likely that it will take time before the aggregate demand begins to shift. People will have to recognize and react to fiscal changes. It is possible that the economy may have already recovered for other reasons, by the time the fiscal policy effects take place, and so they become inflationary.
- - - - Real-world example: In the United States, the most recent large-scale use of contractionary fiscal policy came during President Bill Clinton’s time in office (1993–2001), when he increased taxes on high-income taxpayers and decreased government spending on both defense and welfare. As a result, the United States government went from being in debt to having a budget surplus.
      - Helps to close an inflationary gap by decreasing AD.
        To lower the rate of inflation but may negatively affect unemployment & slow down economic growth.
  - - - Effectiveness of expansionary fiscal policy is affected by the value of the Keynesian multiplier, which is the idea that an increase (or, more generally, a change) in any injection will lead to a greater increase (change) in real GDP or national income because an increase in spending generates additional income that leads to further spending, and thus more income. Its size depends on the size of the withdrawals from the circular flow, as these reflect income not spent on domestic output, → 1/1-MPC (marginal propensity to consume) OR 1/MPS (marginal propensity to save) + MPT (marginal propensity to tax) + MPM (marginal propensity to import).
      - Real-word example: In response to the economic fallout from the spread of Covid-19 in the US, the Senate has passed a bill which will free up $2 trillion to be used for a coronavirus relief package.
      - Helps close a recessionary (deflationary) gap by increasing AD.
        To lower unemployment & boost economic growth but may cause inflation if the economy is too close to or at full-employment.
        Using fiscal policy to increase AD is only advocated by Keynesian/demand-side economists.