Fiscal Policy

Stabilisation Policy: Fiscal
Policy
FP
 Fiscal policy is the use of government spending and taxation to influence the economy.
 Governments typically use fiscal policy to promote strong and sustainable growth and
reduce poverty.
 The role and objectives of fiscal policy gained prominence during the recent global
economic crisis, when governments stepped in to support financial systems, jump-start
growth, and mitigate the impact of the crisis on vulnerable groups.
 Historically, the prominence of fiscal policy as a policy tool has waxed and waned.
 Before 1930, an approach of limited government, or laissez-faire, prevailed.
 With the stock market crash and the Great Depression, policymakers pushed for
governments to play a more proactive role in the economy.
 More recently, countries had scaled back the size and function of government—with
markets taking on an enhanced role in the allocation of goods and services—but when the
global financial crisis threatened worldwide recession, many countries returned to a more
active fiscal policy.
Working of FP
 Governments influence the economy by changing the level and types of taxes, the extent
and composition of spending, and the degree and form of borrowing.
 GDP = C + I + G + NX.
 governments affect economic activity (GDP), controlling G directly and influencing C, I,
and NX indirectly, through changes in taxes, transfers, and spending.
 Fiscal policy that increases aggregate demand directly through an increase in government
spending is typically called expansionary or “loose.” By contrast, fiscal policy is often
considered contractionary or “tight” if it reduces demand via lower spending.
FP- Objectives
 In the short term, governments may focus on macroeconomic stabilization—for example,

expanding spending or cutting taxes to stimulate an ailing economy, or slashing spending
or raising taxes to combat rising inflation or to help reduce external vulnerabilities.
 In the short term, priorities may reflect the business cycle or response to a natural disaster
or a spike in global food or fuel prices.
 In the longer term, the aim may be to foster sustainable growth or reduce poverty with
actions on the supply side to improve infrastructure or education.
 In the longer term, the drivers can be development levels, demographics, or natural
resource endowments.
Inbuilt mechanisms
 Automatic stabilisers
 Stimulus
 Automatic stabilizers are linked to the size of the government, and tend to be larger in
advanced economies. Where stabilizers are larger, there may be less need for stimulus—
tax cuts, subsidies, or public works programs—since both approaches help to soften the
effects of a downturn.
 automatic stabilizers are not subject to implementation lags as discretionary measures
often are
Ministry wise allocations
Largest expenditure contributors
Deficit indicators
Interrelation of MP and FP
 Monetary policy provides stability in the economy in the long run, while built-in stability
of fiscal policy iron out short run fluctuations.
 Monetary policy is more flexible and can be easily adjusted to the changing needs. Fiscal
policy, on the other hand cannot be easily and quickly changed,
 Monetary policy has fiscal implications and fiscal policy has monetary implications,
 Monetary and fiscal policies are interdependent and mutually reinforce each other.
 Monetary and fiscal policies are complementary to each other; when one fails, the other
succeeds.
 Monetary policy is more effective during inflation, while fiscal policy is more effective
during deflation.
 A judicious combination of monetary and fiscal policies is required to meet economic

exigencies.
 Unemployment benefits and income taxation are examples of...
 a) ...uses and sources of seigniorage.
 b) ...automatic stabilizers.
 c) ...pro-cyclical fiscal policy instruments.
 d) ...debt stabilization.
 Suppose your country's public debt to GDP ratio were exploding and you wished to stabilize it. One of your advisers tells
you that by monetizing the debt, you will save the interest payment on the debt since you will pay zero percent on the
monetary base you create. The reason you fire your adviser is that...
 a) ...GDP in the denominator of the ratio will fall too.
 b) ...he clearly confused seigniorage with the inflation tax which is why his recommended policy would fail.
 c) ...this might help to stabilize the debt/GDP ratio but it definitely will give you inflation that is exploding.
 d) ...this is equivalent to defaulting on the sovereign debt which only postpones the debt to a later period.
 Public goods have two criteria, one of which is non-excludability. What does that mean?
 a) It is not possible to exclude individuals from consumption.
 b) It is not possible to produce them without externalities.
 c) Consumption by one does not affect consumption of others.
 d) A and C.
 To secure equity over time, which principle of government finance is generally recommended?
 a) To finance all government spending by loans.
 b) To finance all government spending by taxes.
 c) To finance government capital spending by loans and government current spending by taxes.
 d) To finance government capital spending by taxes and government current spending by loans.

Fiscal Policy

Uploaded by

Copyright:

Available Formats

Fiscal Policy

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Fiscal Policy

Uploaded by

Copyright:

Available Formats

Stabilisation Policy: Fiscal

 In the short term, governments may focus on macroeconomic stabilization—for example,

 A judicious combination of monetary and fiscal policies is required to meet economic

 a) ...uses and sources of seigniorage.

 c) ...pro-cyclical fiscal policy instruments.

 a) ...GDP in the denominator of the ratio will fall too.

 a) It is not possible to exclude individuals from consumption.

 b) It is not possible to produce them without externalities.

 c) Consumption by one does not affect consumption of others.

 a) To finance all government spending by loans.

 b) To finance all government spending by taxes.

You might also like