Fiscal policy
Fiscal policy uses government spending and taxation to influence the economy. Expansionary = more spending / lower taxes. Contractionary = the opposite.
Fiscal policy
The use of government spending (G) and taxation (T) to influence the economy.
Two main types:
1. Expansionary fiscal policy (loose).
- Government spending RISES (more on infrastructure, healthcare, welfare).
- Taxes CUT (income tax, VAT, corporate tax).
- Effect: AD rises β output and employment rise.
- Used in: recessions, low-growth periods.
- Risk: rising government debt, inflation pressure.
2. Contractionary fiscal policy (tight / austerity).
- Government spending CUT.
- Taxes RAISED.
- Effect: AD falls β slower growth, lower inflation.
- Used in: high inflation, overheated economy.
- Risk: unemployment, social hardship.
Government spending categories
Government spending splits into:
- Current spending: wages, welfare, day-to-day operations.
- Capital spending: investment in infrastructure, equipment.
- Transfer payments: welfare, pensions, child benefit.
Taxation categories
- Direct taxes: on income (income tax, NIC, corporation tax).
- Indirect taxes: on goods (VAT, excise duties).
Multiplier effect
When government spends Β£1, the total impact on the economy is MORE THAN Β£1.
Where MPC = marginal propensity to consume.
Example: Β£1 government spending β Β£1 to construction workers β 80% of that to other businesses β and so on.
Strengths of fiscal policy
1. Direct impact on demand. 2. Can target specific sectors or regions. 3. Visible β political accountability. 4. Powerful β large effects possible.
Weaknesses of fiscal policy
1. Time lag. Implementation takes months/years. 2. Government debt rises with expansionary policy. 3. Crowding out: government borrowing may raise interest rates and reduce private investment. 4. Political constraints: hard to cut spending; hard to raise taxes. 5. Effectiveness depends on multiplier (affected by imports, savings).
Recent UK fiscal policy
- 2008-2010: Expansionary (response to recession). Budget deficit rose to 10% GDP.
- 2010-2019: Austerity (cuts to public spending).
- 2020: Massive expansion (COVID β furlough, business support). Borrowing peaked.
- 2021-2024: Gradual consolidation.
Edexcel application. When discussing fiscal policy, identify: (a) tool (spending or tax), (b) direction (loose or tight), (c) target objective (growth, inflation, etc.), (d) timing and risks.
- Fiscal policy = government spending + taxation.
- Expansionary = more spending, lower taxes β boost demand.
- Contractionary = less spending, higher taxes β cool economy.
- Multiplier amplifies impact.
- Strengths: direct, targeted; weaknesses: debt, time lag, crowding out.