Problems/Evaluations Fiscal Policy

• Merits of expansionary fiscal policy include increasing aggregate demand, economic growth, and lowering unemployment
• Expansionary fiscal policy can lead to higher government budget deficits and total debt, potentially requiring cuts in government spending or increases in taxation
• Higher government debt from expansionary fiscal policy comes with an opportunity cost in the form of paying debt interest, which could have been used more productively in the economy
• Crowding out effect occurs when government borrowing increases demand for loanable funds, leading to higher interest rates and potentially crowding out private sector investment
• Expansionary fiscal policy can have time lags, where the impact of government spending or tax cuts on the economy may not be immediate
• Problems with expansionary fiscal policy include macro objective trade-offs such as higher demand-pull inflation, potential conflict of macro objectives, and widening current account deficit
• Ricardian equivalence theory suggests that if households anticipate future tax rises due to expansionary fiscal policy, they may save any tax cuts received, reducing the boost to the economy
• Possible funding sources for expansionary fiscal policy

  • Cuts to government spending in various areas such as health, education, infrastructure, public sector wages, welfare
  • Rise in income tax or corporation tax
  • Increase in regressive taxation
• Government spending may lead to X inefficiency and excess costs due to lack of profit motive and potential wasteful spending in infrastructure projects or government organizations
• Critique of expansionary fiscal policy by questioning the size of the output gap
• Households will take time before an income tax cut will be spent
• Lags in government spending on infrastructure projects


  Mean rounds of government spending
• If the multiplier value is large, there is less need for heavy expansionary fiscal policy
• Effectiveness of expansionary fiscal policy depends on the size of the multiplier
• Expansionary fiscal policy is a Keynesian idea
• Current state of government finances is a key point to consider before enacting expansionary fiscal policy
• Short-run and long-run effects of expansionary fiscal policy on government finances
• Tax cuts (income tax cuts, corporation tax cuts) generate long-term economic activity and tax returns to the government over time
• Expansionary fiscal policy


  • Very much a Keynesian idea
• Effectiveness of expansionary fiscal policy depends on the size of the output gap
• Corporation tax cut will take time before businesses invest those increased retained profits
• Consumer and business confidence can impact the effectiveness of income tax cuts and corporation tax cuts
• Government spending on education, infrastructure, healthcare provides long-run growth and benefits to the economy
• If the multiplier value is large, the impact of expansionary fiscal policy is likely to be greater
• Tax cuts (income tax cuts and corporation tax cuts)


  Take time to feed through into the economy
• If government finances are in a stable way, expansionary fiscal policy can be afforded