Fiscal policy looks at how government spend their money and how they control their taxes.
There are 2 types of fiscal policy:
Contractionary fiscal policy: Where the government reduce spending and / or when they make taxes higher, they try to increase its PSBR( public sector borrowing requirement) to fund the tax drops they also do this to reduce its surplus on its budget for the fiscal year.
Expansionary fiscal policy: Where the government cut taxes or increase government spending. They will increase the amount the government borrows to fund the expenditure.
Government Expenditure
Government expenditure covers all spending by the public sector. The government spends money on many things including:
- Education
- Defence
- Welfare benefits
- Healthcare
- Infrastructure
- Police
Government Borrowing
As well as gaining revenue through taxation the government can also finance their spending through borrowing. The public sector net cash requirement (PSNCR) measures the annual borrowing requirement of the government in an economy
Direct and Indirect Taxes
Direct taxes are taxes of income and expenditure. e.g. income tax, corporation tax (levied on company profits).
Indirect taxes are taxes such as VAT (value added tax), changes in this type of tax has a rapid effect on the level of economic activity. e.g. an increase in VAT will cut consumption
Influence on Aggregate Demand / Aggregate Supply
Fiscal Policy and Aggregate Demand
Taxation influences the AD curve because:
- An increase in taxation will decrease the level of consumption in the economy
- An increase in taxation will increase the level of government spending in the economy
- A decrease in taxation will increase the level of consumption in the economy
- A decrease in taxation can decrease the level of government expenditure in the economy
- The impact of a change in government expenditure depends on the size of the multiplier
- Governments can utilise fiscal policy to control the level of AD in the economy
There can be problems with this due to:
- Time lags
- The size of the multiplier
- Fiscal crowding out
- Peoples reaction to cuts / rises in taxation
Fiscal Policy and AS
Fiscal policy can be used to increase the productive capacity of the economy
This is because government expenditure can be used to:
- Increase the skill levels of workers
- Provide economic incentives to firms
- Increase factor mobility
