IGCSEEconomicsCIERevision Notes4. Government & the Macroeconomy4.3 Fiscal Policy4.3.3 Fiscal Policy Measures

Fiscal Policy Measures (CIE IGCSE Economics)

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Steve Vorster

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Fiscal Policy Defined

  • Fiscal Policy involves the use of government spending & taxation (revenue) to influence total (aggregate) demand in the economy
     
  • Fiscal policy can be expansionary in order to generate further economic growth
    • Expansionary policies include reducing taxes or increasing government spending
       
  • Fiscal policy can be contractionary in order to slow down economic growth or reduce inflation
    • Contractionary policies include increasing taxes or decreasing government spending 
       
  • Fiscal Policy is usually presented annually by the Government through the  Government Budget 
    • A balanced budget means that government revenue = government expenditure
    • A budget deficit means that government revenue < government expenditure
    • A budget surplus means that government revenue > government expenditure

  • A budget deficit has to be financed through public sector borrowing
    • This borrowing gets added to the public debt

The Effects of Fiscal Policy on Government Macroeconomic Aims

  • To understand the effects of fiscal policy on an economy, it is useful to know how total demand (gross domestic product) is calculated

  • Total (aggregate) demand = household consumption (C) + firms investment (I) + government spending (G) + exports (X) - imports (M)
    • Total demand = C + I + G + (X - M)

  • From this, it is logical that changes to fiscal policy can influence any of these components - & often several of them at once


Examples of The Impact of Contractionary Fiscal Policy


Example 1


The Government increases income tax levels

Effect on the economy

Consumers pay more tax → discretionary income reduces → consumption reduces → total demand reduces

Impact on macroeconomic aims

  • Economic growth slows down
  • Inflation eases
  • Unemployment may increase as output is falling & fewer workers are required
  • Current Account Improves (with less income, imports may fall)

  


Example 2


The Government freezes/reduces public sector workers pay

Effect on the economy

Wages stagnate or reduce → Consumer confidence falls → consumption decreases → total demand decreases

Impact on macroeconomic aims

  • Economic growth slows down
  • Inflation eases
  • Unemployment may increase as output is falling
  • Current Account Improves (with less income, imports may fall)

  


Example 3


The Government cuts Government spending in their Budget

Effect on the economy

Less demand for goods/services → less income for firms → output & profits decrease → total demand decreases

Impact on macroeconomic aims

  • Economic growth slows down
  • Inflation eases
  • Unemployment may increase as output is falling
  • Current Account Improves (with less income, imports may fall)
  • Less corporation tax available for redistribution

 

Examples of The Impact of Expansionary Fiscal Policy


Example 1


The Government decreases corporation tax

Effect on the economy

Firms net profits increase → investment by firms increases → total demand increases

Impact on macroeconomic aims

  • Economic growth increases
  • Inflation rises
  • Unemployment may decrease as output is rising which requires more workers
  • Current Account - unsure - exports may rise due to new investments in the economy, but imports may rise due to higher income generated by the investment

  


Example 2


The Government increases unemployment benefits

Effect on the economy

Household income increases → consumption increases → total demand increases

Impact on macroeconomic aims

  • Economic growth increases
  • Inflation rises
  • Unemployment may decrease as output is rising which requires more workers (although increased unemployment benefits may discourage some people from entering the labour market)
  • Current Account unlikely to change as this policy helps the poorest & imports are unlikely to increase
  • Redistribution of income has increased & there is more equity in society

   

Strengths of Fiscal Policy

  • Spending can be targeted on specific industries
  • Short time lag as compared with monetary policy (effects of fiscal policy are seen sooner)
  • Redistributes income through taxation
  • Reduces negative externalities through taxation
  • Increased consumption of merit/public goods
  • Short term government spending can lead to an increase in the total supply of an economy
    • E.g. Building a new airport immediately increases government spending and total demand, but when it is built, the potential output will have increased (Production Possibility Curve has shifted outward)


Weaknesses of Fiscal Policy

  • Policies can fluctuate significantly when new governments are elected 
    • Long term infrastructure projects may lack follow-through
  • Increased government spending can create budget deficits
    • Repaying this debt may lead to austerity on future generations
  • Conflicts between objectives
    • E.g. Cutting taxes to increase economic growth may cause inflation

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    Steve Vorster

    Author: Steve Vorster

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.