Fiscal Policy - Gov Spending + Taxation

• Expansionary fiscal policy aims to boost aggregate demand, leading to higher economic growth, reduced unemployment, and potential demand-pull inflation
• In reality, controlling inflation is not the government's job, but expansionary fiscal policy can be used to redistribute income and reduce income inequality
• Fiscal policy

  A macroeconomic policy that involves changes to government spending and taxation to influence aggregate demand in the economy
• Contractionary fiscal policy


  • Changes to government spending and taxation that aim to reduce aggregate demand
• Expansionary fiscal policy

  • Changes to government spending and taxation that aim to boost aggregate demand
• In theory, expansionary fiscal policy can help increase economic growth, reduce unemployment, and increase demand-pull inflation
• The multiplier effect is a concept where an increase in aggregate demand leads to higher incomes, more spending, and a cycle of increased spending and income, resulting in even higher economic growth
• Contractionary fiscal policy aims to reduce aggregate demand to cool down an overheating economy, reduce inflation, reduce budget deficit, control government finances, and redistribute income
• Reduction in regressive taxation

  Increases disposable income for the poor more than the rich, boosting consumption and AD
• Reduction in income tax incentivizes workers to be more productive


  Increases productivity of labor, boosting LRAS
• Expansionary fiscal policy can boost long-run aggregate supply (LRAS)


  Side effect of certain policies boosting the productive potential of the economy
• More spending leads to more ad and more incomes

  Creates a virtuous cycle of spending and income, resulting in an even higher increase in AD and economic growth
• Government spending on education, health, and infrastructure boosts productivity of labor and capital


  Increases LRAS and potentially boosts quantity of capital
• Primary focus of expansionary fiscal policy is to boost aggregate demand
• Reduction in corporation tax boosts investment


  Boosts LRAS via increase in quantity and quality of capital and improvement in productive efficiency
• Government spending on healthcare, education, infrastructure, and public sector wages

  Boosts G in the aggregate demand equation and AD
• Cutting income tax increases disposable income

  Increases marginal propensity to consume, boosting consumption in the aggregate demand equation and AD
• Reduction in income tax incentivizes inactive population to become active


  Increases quantity of labor and boosts LRAS
• Multiplier linked to expansionary fiscal policies

  Focus on tax policies, such as cutting income tax for higher income brackets, reducing income tax rates for lower income brackets, widening tax-free allowance, or tax bands
• Reduction in corporation tax

  Increases retained profit for businesses, leading to increased investment and boosting AD