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Fiscal Policy Essay

894 words - 4 pages

Topic 4 – Fiscal Policy
Refers to the governments choices regarding the overall level of government purchases or taxes

* Government spending – on health sector, education, infrastructure, defence.
* Taxation policy – income tax, sales tax (VAT), corporate tax, capital gains tax.

Fiscal policy and aggregate demand

* Government spending – increase in G spending → AD shifting right
* e.g. Gov places £10 billion order for new school buildings → building contractor has increased demand for output → hires more staff and increases production.

* Taxation –
* Income tax cut → consumption increases → AD shifting right
* Corporate tax cut → investment increases ...view middle of the document...

If gov initial purchase was 10 billion then times by 4 = spending generated £40 billion of demand for goods and services.
* Hence, the larger the MPC the larger the multiplier.

The Crowding-Out Effect
The offset in aggregate demand resulting from when expansionary fiscal policy raises the interest rate and thereby reduces investment spending.

* Whilst an increase in gov purchases stimulates AD for goods and services, this causes national incomes to rise → increase in demand for money (MD shifts right) → causing the interest rate to rise → reduction in investment spending and chokes off AD.

Fiscal Policy and Aggregate Supply
NEED TO FIND SOME NOTES HARD TO UNDERSTAND LECTURE SLIDES

Automatic Stabilisers
Changes in fiscal policy that stimulate AD when the economy goes in recession, without policymakers having to take any deliberate action

* Tax System – When economy in recession, amount of taxes collected by gov reduces as income tax depends on households’ incomes and corporate tax depends on firms profits → this auto tax cut stimulates AD → reducing magnitude of eco fluctuations.

* Government Spending – e.g. when economy in recession → workers are laid off → increase in unemployment benefits, welfare benefits and other income support → Auto increase in gov spending stimulates AD

Active Stabilsation Policy
AD management using counter cyclical fiscal and/or monetary policy

* Positives -
* STUCK

* Negatives -
* Primary argument against active monetary and fiscal policy is that the effects of these policies are uncertain in terms of magnitude and timing.
* Example for timing problems when changing interest rates – the effects it has on consumer spending will vary as to the type of mortgage people have e.g. those that have mortgages that fluctuate with interest rate will have less money to spend immediately, however those that have a fixed rate for say two years will not be affected immediately so there is a time lag.
* Other than that interest rate rising will still effect consumer spending because people buying goods and services on...

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