In the following video you’ll learn about one of the demand-management approaches towards
the economy.
We’ll explore what fiscal policy is, what it does and how it works.
Fiscal policy includes the use of changes in government spending and taxation in order
to influence the level of aggregate demand within an economy.
Government expenditure is funded by tax revenue which is collected from individuals and organisations.
There are many different types of taxes, and they will be covered in greater detail in
A2.
Government spending includes a variety of categories, including defence, which makes
up a significant portion of the American government’s budget.
Additionally there is spending allocated to the development of infrastructure in a country
aimed at improving rail transport, shipping, highways and roads.
At a basic level the national budget is the expected government revenues and expenditures
for a financial year.
A budget deficit occurs within a year when government spending is greater than the amount
of money collected as tax revenue.
A cyclical budget deficit occurs when the government ends up running a deficit as a
result of increased expenditure and decreased tax revenues.
The cause of a cyclical budget deficit is a slowdown or recession in the economy.
A structural budget deficit occurs when the government is consistently spending more than
they have collected in tax revenues.
The state of the economy is irrelevant.
If a country is regularly spending more than it collects in tax, it can be described as
fiscally irresponsible.
A budget surplus occurs within a year when government spending is less than the amount
of money collected as tax revenue.
The national debt is the accumulation of a nation’s deficits over time.
It can be reduced when a government runs a budget surplus and increases every time the
government runs a budget deficit.
If you visit www.usdebtclock.org you can see what the current national debt is.
In fact, once you’ve done that, leave the value of the debt in the comments.
It’ll be interesting to see how this changes over the years.
In this picture you’re seeing Franklin Delano Roosevelt who entered the Presidential office
in 1933.
He was tasked with reviving the American economy which was in the grips of the Great Depression
at the time.
He aggressively pursued projects that were aimed at reviving the economy.
These actions fall under the category of discretionary fiscal policy.
These are actions that are taken in response to economic events, and are not inherently
built into government policy.
Discretionary fiscal policy is held in contrast to automatic stabilisers.
These are economic policies designed to offset changes in the economic activity of a nation.
They tend to limit the impact of changes in the business cycle.
For example, a progressive tax system will collect more in tax when the economy is expanding
and will also reduce excessive spending as people earn more money.
On the other side, government spending on benefits will increase as the economy slows
down and people lose their jobs.
Automatic stabilisers are built into government policy and ‘automatically’ kick in as
economic activity fluctuates.
Expansionary fiscal policy is fiscal policy aimed at increasing the level of aggregate
demand within an economy.
This could be done to reflate the economy by increasing output and decreasing unemployment.
Inflation would be less of a concern at a time like this.
Consider the following position of the economy.
If real GDP is currently at Y* and the price level is at PL*, we are far away from our
full employment level of output.
The government would enact expansionary fiscal policy, by increasing spending, reducing taxes
or a combination of the both with hopes of increasing AD from AD to AD1.
This, in turn, would increase real GDP to Y1 with an acceptable trade off of the increasing
price level from PL* to PL1. Real GDP rises, the price level rises and unemployment falls.
It’s important to remember, fiscal policy does not work perfectly.
There’s a time lag in adopting policy and for it to take effect.
You could also consider whether the government has increased spending or decreased taxes
sufficiently.
Contractionary fiscal policy is fiscal policy aimed at decreasing the level of aggregate
demand within an economy.
This could be an attempt to cool off an economy and reduce inflationary pressures.
Now let’s consider an economy operating at full-employment.
The government wants to reign in economic activity so they cut spending, increase taxes
or a combination of both.
This will eventually reduce AD from AD to AD1, causing a decrease in the price level
from PL* to PL1 and a fall in real GDP from Yfe to Y1.
Again, you should always evaluate fiscal policy with respect to the time lag and its magnitude.
How much fiscal policy is enough and how long will it take to be effective?
Consider other consequences also and perhaps other tools that may be more effective in
addressing economic problems.
So we’ve taken a look at fiscal policy, its tools and how it works.
We’ll look at it in more detail in this unit and explore it at much greater depth
at A2.
For now, if you have any questions or comments, do leave them below.
If you have any questions or comments, email me at enhancetuition@gmail.com or visit me
at www.enhancetuition.co.uk.
That’s us done for now and I will see you in the next one!