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Chapter 12: Fiscal policy - Coggle Diagram
Chapter 12: Fiscal policy
Discretionary management of government spending (G)/taxation (T) to influence the level of AD and economic activity.
Fiscal policy!
Expansionary fiscal policy (
increase
AD/output)
Increasing government spending:
on G&S, or increase in public work projects like public goods (roads).
Reducing taxes:
increase in RNY -> increased C -> permanently increases RNY by a multiple
Choosing one over the other depends on factors like size of public sector. Increase in G is more expansionary than T, as though disposable income increases, only an additional part of that is consumed while the rest is saved ->
no equivalent increase
Contractionary fiscal policy (decrease AD/inflation by causing budget surplus)
Reducing government spending
Increasing taxation
Issues
magnitude:
crowding-out effect (fall in private investment, reducing I and C) or size of multiplier (withdrawals like high import leakage or anticipation
timing (lag):
recognition (recognising months after it's an issue), administrative (time btw recog and action) and operational (time and impact of action)
macroecons tradeoffs:
depending on type of inflation (may worsen existing problems). also ineffective for small open econ (SG) due to rising IR
implementation:
political pressure (what to cut) and debt level (budget deficit)
High budget deficit with FP:
Austerity measures (less G on public goods)
Future tax increase: transferring welfare from future to current gen
Loss of confidence: pessimistic expectation on returning debt (-> austerity)
Taxation
Purpose
Revenue: financial provision of G&S which are inefficiently provided by the market (healthcare)
Economic: change pattern of demand through
indirect taxes
and resource allocation
Social: reduce income inequality and wealth distribution (through progressive income taxes)
Types of taxes
Direct:
paid directly to the government (Tax Department). usually borne by the person paying the tax (not passed on to others through higher P. Does not shift AS.
Indirect:
taxes on expenditure. tax can be transferred over to consumer.
Effects on production
Labour supply:
either income effect (people work longer hours so C constant) or substitution effect (sacrificing work for leisure due to lower opp cost)
Enterprise: disincentive for entrepreneurs when T increases (same risk, lower reward)
Resource allocation:
progressive income tax affecting entry to lucrative professions, or indirect taxes where relative prices are changed.
Savings: reduces people's willingness and ability to save
Investments: decrease in corporate tax causes profit to increase after tax, causing increased profitability of investment and increased I
OR
corp tax leads to budget deficit, increasing govt borrowing and decreasing I (crowding out effect)
Inflation:
increasing GPL (when GST rises), (inflationary spiral explanation in inflation mindmap)
Government expenditure (autonomous - may not directly affect tax)
Types of G
Current/operating expenditure: day-to-day incurred expenditure (recurrent)
Development expenditure: for economic/social development
Effects
Resource allocation: resources diverted from one industry to another (through grants and subsidies for specific industries)
Income/wealth distribution: expenditure mainly benefits the poor - reduces inequality/distribution
PEG: expenditure on infrastructure, skills training expands productive capacity
Economic stability: G changes to affect AD -> affects level of employment, output, income
IN SG CONTEXT
used in times of recession (stimulate the economy)
high import leakage, high MPS,
low K
. imports and savings also increase
SG also highly dependent on foreign investments (due to being an open economy) -> unable to raise tax rates to maintain competitive tax regime
Budget surplus/deficit
When government spending (expenditure) < government revenue (taxes) and vice versa.
Effects
Economic growth:
increased tax -> decrease in income -> decreased C and decreased G -> decrease in RNY
Unemployment:
RNY falls, surplus in stocks, cut back on production, FOP decreased. labour as derived demand would fall, and cyclical unemployment would increase.
Inflation:
decrease in AD -> fall in GPL.
Increases price competitiveness of exports -> increased Qd of exports -> increase in export revenue (assuming many close substs available)
(E) BOP: budget surplus -> economy's reserves and can be saved for unexpected economic recession/investing reserves
(E) Exchange rates: capital outflow -> increased MS -> depreciation -> demand for exports increases -> price of imports increases (but assuming inelastic, demand fall more than proportionate) -> net X increase