Chapter 17 Summary- EKN120

EKN 120

Chapter 17: Fiscal Policy and the Economics of taxation
Fiscal Policy
 Fiscal policy involves decisions about government spending and taxation
 There are 2 types
o Expansionary: Increase in government spending and decrease in tax
o Contractionary: Decrease in government spending and increase in tax

Objectives of Fiscal Policy
 Full employment
 Price stability
 Accelerating the rate of economic development
 Optimum allocation of resources
 Equitable distribution of income and wealth
 Economic stability
 Capital formation and growth
 Encouraging investment
 Taxation and Government spending are the tools of fiscal policy

Expansionary Fiscal Policy and AD-AS Model
 Expansionary fiscal policy will lead to an increase in the size of a government’s budget deficit
(G>T)
 This might lead to a higher inflation in the short run
 Expansionary fiscal policy is used to push the economy out of recession (stimulate growth via
AD)
 The idea is to put more money into consumer’s hands, so they spend more




Contractionary Fiscal Policy and AD-AS Model
 Contractionary fiscal policy will lead to a decrease in the size of a government’s budget deficit
 Contractionary fiscal policy is used to slow down economic growth

,  They do this to stamp out inflation
 Taxes are increased and spending is cut




Problems, Criticisms and Complications of Implementing Fiscal policy
 Problems of timing:
o Recognition lag
o Administrative lag
o Operational lag
 Political considerations
o Political business cycles
 Future policy reversals
 Offsetting provincial and local finance
 Crowding-out effect
 Current thinking on fiscal policy

Crowding-out Effect