Fiscal Policy

Question 1

State + explain the macro effects of expansionary fiscal policy.

Answer 1

• Growth: higher SR growth.
• Unemployment: reduction in cyclical unemployment.
• Inflation: higher demand-pull inflation.
• Trade / CA Position: higher CA deficit - higher inflation can erode X competitiveness. Higher growth + lower unemployment - increasing incomes - increasing M expenditure.
• Gov Finances: rising budget deficits - worsening national debt - LR implications - burdening future generations.

Question 2

State + explain the micro effects of expansionary fiscal policy.

Answer 2

• Crowding Out: effect takes place in loanable funds market.
• Solve Market Failures: increasing G on health, education, infrastructure - solves key market failures, improving allocative efficiency, positive externalities.
• Public Services Impact: spending more on education - smaller class sizes, easier to recruit teachers, improving teacher quality. More spending on healthcare - less waiting times, key surgery performed quickly, better quality of healthcare.
• X-Inefficiency: wasteful gov spending due to lack of profit motive, opportunity cost argument.
• Profits For Firms: tax cuts (i..e indirect + direct) increases retained profits.

Question 3

State + explain the macro effects of contractionary fiscal policy.

Answer 3

• Gov Finances: reduces budget deficits moving towards budget surplus. With more confidence with state of gov finances - coupon rates on gov bonds can come down - cheaper + easier for gov to borrow overtime with better credit ratings. FDI could be promoted with stronger, more sustainable gov finances. Fiscal space to fund expansionary fiscal policy during next recession.
• Inflation: reduces demand pull inflation.
• Current Account: improves CA deficit as an expenditure reducing policy.
• Growth: lower growth
• Unemployment: higher cyclical unemployment.
• Productive Capacity Constraints: by cutting spending on education, healthcare, infrastructure - productive capacity constraints - limits LRAS.

Question 4

State + explain the micro effects of contractionary fiscal policy.

Answer 4

• Crowding Out: less chance of crowding out of private sector.
• X-Inefficiency: less likely to occur - less G, less wasteful G - lower opportunity cost.
• Public Services Impact: lower G on education, healthcare, public transport - bad for people who rely on services.
• Inequality: by cutting G + raising regressive taxes - widens income inequality.