Fiscal policy

definition
1. decisions by national govt regarding the nature, level & composition of govt expenditure, taxation & borrowing, aimed at pursuing econ goals
GOALS of fiscal policy
1. macro level
  1. econ growth
  2. job creation
  3. price stability
  4. Balance of Payments stability
  5. poverty alleviation
2. sectoral level
  1. development of particular econ sectors, e.g. agriculture, tourism
  2. pursuing social goals pertaining to particular sectors, e.g. housing, education, health, etc.
3. micro level
  1. i.e. fiscal action aimed at a single econ participant
    1. improving efficiency by addressing negative externalities w.r.t. a particular product, e.g. tobacco, or activity, e.g. toxic waste disposal
    2. Combating poverty by intervening in the market for a product (e.g. bread subsidy)
    3. fiscal policy can pursue goals w.r.t. a particular geographic area
INSTRUMENTS of fiscal policy
1. Macro instruments
  1. total govt expenditure
  2. total tax
  3. budget deficit & debt
  4. the way in which the budget deficit is financed
2. Micro instruments
  1. various expenditure functions, e.g. education, health & defense
  2. votes & programmes
  3. different kinds of taxes & their rates
  4. different dimensions of public debt, e.g. maturity, ownership structure, etc.
Effectiveness of fiscal policy
1. explained by different schools of thought
  1. Keynesian economics
    1. anti-cyclical fiscal policy
      1. in recessionary conditions govts should increase spending or reduce taxes to stimulate AD
    2. govt's responsibility to actively manage aggregate demand so that it equals aggregate supply at the full employment level of income
      1. assumes main role of fiscal policy is to STABILISE economy
    3. apart from using taxes & govt expenditure to stabilise economy, govt can also use income taxes & unemployment benefits
      1. use these "automatic stabilisers" to trigger changes in tax revenue that would stabilise AD, income & output
    4. agreement that these stabilising instruments can only REDUCE economic instability, not eliminate it entirely
    5. dominated fiscal policy until early 1970's
      1. called into question with stagflation brought on by oil crisis of 1973
        became evident that Keynesian economics was really about short-term demand management, but did not provide a solution to structural unemployment
  2. Structural approach to fiscal policy
    1. Emerged from growing perception that anti-cyclical fiscal policy is ineffective and could in fact make economy more volatile
    2. Key aspects
      1. keep public debt at a sustainable level by avoiding high budget deficits or reducing it to acceptable levels
      2. keep overall tax burden at a level that doesn't distort incentives to work, save & invest
        income & substitution effects NB
      3. keep govt spending in check to avoid crowding out private activity, inflationary financing & disincentive effects of an excessive tax burden
    3. Basic assumptions
      1. market-based solutions to social & economic situations may not always be effective, thus direct controls and interventions may be required from time to time
        direct interventions supported, e.g. rent ceilings, import quotas, wage and price controls
      2. interventions necessary to restore growth even though they may reduce allocative efficiency in the short-term
  3. Supply-side economists
    1. advocate a particular brand of fiscal policy as a cure for stagflation
    2. Use Laffer curve to argue relative size of govt in economy is determined by micro incentives
    3. recommend a reduction in marginal tax rates and a corresponding reduction in govt spending

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	Created by Heleen Hofmeyr over 9 years ago