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Mind Map by luke hodgkins, updated more than 1 year ago
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Fiscal Policy
- Involves the government changing levels of Taxation and Government spending
in order to influence AD and the level of economic activity
- AD is the total level of planned expenditure in an economy (AD = C+ I + G + X – M)
- Government spending
- Investment
- Consumer spending
- eXports-iMports
- Government spending
- AD is the total level of planned expenditure in an economy (AD = C+ I + G + X – M)
- PURPOSE
- Stimulate economic growth in a
period of recession
- Keep inflation low (>2% target)
- Stabilise economic growth
- Avoid a boom and bust
economic cycle
- Avoid a boom and bust
economic cycle
- Stimulate economic growth in a
period of recession
- EXPANSIONARY
- Increasing AD
- Increasing G or reducing T
- Reducing T will increase C as consumers
will have more disposable Y
- This will tend worsen the government budget deficit and
the government will need to increase borrowing.
- This will tend worsen the government budget deficit and
the government will need to increase borrowing.
- Reducing T will increase C as consumers
will have more disposable Y
- Increasing G or reducing T
- Increasing AD
- DEFLATIONARY
- Decreasing AD
- Cut G and Increase T
- Higher T will decrease C
- Deflationary Fiscal policy will tend to cause an
improvement in the government budget deficit.
- Deflationary Fiscal policy will tend to cause an
improvement in the government budget deficit.
- Higher T will decrease C
- Cut G and Increase T
- Decreasing AD
- In 2009, the government pursued expansionary fiscal policy. In response to a
deep recession (GDP fell 6%) the government cut VAT in a bid to boost
consumer spending. This caused a big rise in government borrowing (2009-10).
- (Government borrowing also rose because of the recession
leading to lower tax revenue)
- When the new coalition government came into power in
May 2010, they argued the deficit was too high and then
announced plans to reduce government borrowing.
- This involved spending limits. This austerity measures were
a factor in causing lower economic growth in 2011 and 2012.
- This involved spending limits. This austerity measures were
a factor in causing lower economic growth in 2011 and 2012.
- When the new coalition government came into power in
May 2010, they argued the deficit was too high and then
announced plans to reduce government borrowing.
- (Government borrowing also rose because of the recession
leading to lower tax revenue)
- The multiplier effect.
- When an increase in injections causes a
bigger final increase in Real GDP.
- Injections (J) – This is an increase of
expenditure into the circular flow, it includes
govt spending(G), Exports (X) and Investment (I)
- Withdrawals (W) – This is leakages from the circular flow This
is household income that is not spent on the circular flow. It
includes: Net savings (S) + Net Taxes (T) + Net Imports (M)
- Injections (J) – This is an increase of
expenditure into the circular flow, it includes
govt spending(G), Exports (X) and Investment (I)
- When an increase in injections causes a
bigger final increase in Real GDP.
- CRITICISMS
- The government may have poor information
about the state of the economy so may not be
able to identify what it needs
- Time lags
- Crowding out
- An expansionary policy involves the government borrowing from
the private sector to finance the increase in G. This depletes the
private sector's funds and may reduce private investment.
- An expansionary policy involves the government borrowing from
the private sector to finance the increase in G. This depletes the
private sector's funds and may reduce private investment.
- Inefficient
- Free market economists argue that higher government spending will tend to be wasted on
inefficient spending projects. Also, it can then be difficult to reduce spending in the future
- Free market economists argue that higher government spending will tend to be wasted on
inefficient spending projects. Also, it can then be difficult to reduce spending in the future
- Higher borrowing costs. Debt repayment
- The government may have poor information
about the state of the economy so may not be
able to identify what it needs
- EVALUATION
- It depends on the size of the multiplier.
- It depends on the state of the economy. Fiscal policy is most effective in a
deep recession where monetary policy is insufficient to boost demand.
- Higher government spending will not cause crowding out
because the private sector saving has increased substantially.
- Higher government spending will not cause crowding out
because the private sector saving has increased substantially.
- It depends on other factors in the economy. .
- For example, if the government pursue expansionary fiscal
policy, but interest rates rise and the global economy is in a
recession, it may be insufficient to boost demand
- For example, if the government pursue expansionary fiscal
policy, but interest rates rise and the global economy is in a
recession, it may be insufficient to boost demand
- Bond yields
- It depends on the size of the multiplier.
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