Chapter 19 · Macroeconomics
Fiscal Policy
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Key Definitions
- Fiscal policy
- The use of government spending and taxation to influence aggregate demand and the allocation of resources.
- Expansionary fiscal policy
- Raising government spending and/ or cutting taxes to increase aggregate demand.
- Contractionary fiscal policy
- Cutting government spending and/ or raising taxes to reduce aggregate demand.
- Crowding out
- Government borrowing raises interest rates and reduces private spending.
Core Concepts
Expansionary fiscal policy
- Raise government spending and cut taxes.
- Higher disposable income and after-tax profit, feeding through the multiplier.
- When AD exceeds AS, a shortage emerges and pushes up prices.
Sustainable growth
- R&D spending on green energy supports growth that can be sustained.
Inclusive growth
- A progressive tax system and redistributive subsidies share the gains.
- SkillsFuture develops human capital and improves occupational mobility.
Unemployment
- Expansionary policy reduces demand-deficient unemployment.
- Training and skills upgrades reduce frictional and structural skills mismatch.
Price stability
- Expansionary policy counters deflation.
- Contractionary policy (cut G, raise taxes) counters demand-pull inflation.
Balance of trade
- Contractionary policy reduces a trade deficit by expenditure-reducing effects.
- Lower inflation improves export competitiveness.
Evaluation Points
- The size of the multiplier is uncertain and hard to estimate in advance.
- Crowding out can offset expansion: government borrowing pushes up interest rates and cuts private investment and consumption.
Essay Outline
- Define fiscal policy and state the expansionary and contractionary levers.
- Explain the transmission from G and tax changes through income to AD and output via the multiplier.
- Link expansionary policy to unemployment, deflation and growth objectives.
- Analyse crowding out as the key limitation, then note timing and measurement problems.
- Conclude with the policy mix and conditions under which fiscal stimulus is most effective.