3.6 Demand management - fiscal policy

Objective notes

7 learning objectives

3.6.1Fiscal policy

• Fiscal policy uses government revenue and expenditure

• Revenue sources include direct taxes, indirect taxes, state-owned enterprise sales, and sale of government assets

• Expenditure includes current spending, capital spending, and transfer payments

3.6.2Fiscal policy goals

• Goals include low stable inflation, low unemployment, long-term growth conditions, reduced business cycle fluctuations, equity in income distribution, and external balance

3.6.3Expansionary and contractionary fiscal policy

• Expansionary fiscal policy can close deflationary or recessionary gaps

• Contractionary fiscal policy can close inflationary gaps

• Diagram: AD/AS showing expansionary and contractionary fiscal policy in Keynesian and monetarist/new classical models

3.6.4(HL)—Keynesian multiplier

• The Keynesian multiplier equals 1 / (1 - MPC) or 1 / (MPS + MPT + MPM)

• MPC is marginal propensity to consume; MPS to save; MPT to tax; MPM to import

• Calculation [HL]: Keynesian multiplier

• Calculation [HL]: effect on GDP from a change in investment, government spending, or exports

3.6.5Effectiveness of fiscal policy

• Constraints include political pressure, time lags, and sustainable debt

• Strengths include targeting specific sectors and effective government spending in deep recessions

• Evaluation considers effects on growth, unemployment, and price stability

3.6.6(HL)—Automatic stabilizers

• Automatic stabilizers include progressive taxes and unemployment benefits

• They help moderate business cycle fluctuations without new discretionary policy

3.6.7(HL)—Crowding out

• Crowding out is a constraint on fiscal policy

• Diagram: crowding-out effect