Y1 29) Fiscal Policy – Government Spending and Taxation

Y1 29) Fiscal Policy – Government Spending and Taxation. Video covering the basics of expansionary fiscal policy using government spending and taxation

Hi everybody fiscal policy is a macroeconomic policy that involves changes to government spending in taxation in order to influence aggregate demand in the economy so very much a demand side macro policy here it can be expansionary in nature expansionary fiscal policy which is changes to g and t that aims to boost aggregate demand or it can be contractionary in

Nature contractionary fiscal policy which it changes to g nt in order to reduce ad so why would a government look to use expansionary fiscal policy and boost an aggregate demand well the first reason is to increase economic growth so if growth is sluggish or if the economy’s in a recession a boost to growth might be necessary if ad increases we get that increasing

Growth could also be to reduce unemployment cyclical unemployment again in a recession if the aggregate demand shifts to the right there is going to be more goods and services being produced in the economy firms are therefore going to need more workers to produce that output labor is a derived amount therefore employment will rise unemployment will fall another

Reason in theory would be to increase demand pull inflation ad shifts to the right we get more inflation demand pull inflation so in theory we can say that in reality not really because it’s not the government’s job to control inflation but in theory we can say it so if the inflation rate is below target maybe a slight increase in inflation will be desirable through

Expansionary fiscal policy and then the last reason really isn’t to do with aggregate demand it’s more to do with the redistribution of income to reduce income inequality so for example via government spending on welfare benefits which is a top-up of income for those on lower incomes but also reduction in tax rates for those in lower income tax bounds or maybe a

Reduction in regressive taxation will help to reduce income inequality in the economy what about contractionary fiscal policy well this is all about reducing ad why might the government want to do that well the first reason will be to cool the economy down if the economy is overheating we have high rates of demand upon inflation reductions an ad via fiscal policy

Can help to reduce the landfill inflation again in theory we can say that not in reality because it’s a central bank’s job to control inflation and hit the inflation target so in reality the major reason will be number two contractionary fiscal policy not really for an ad effect but to reduce the budget deficit to reduce the amount of borrowing that the government

Is doing early and therefore to reduce the overall level of debt that the government has so i’ve been the primary reason to try and control government finances but another reason again to redistribute income again not linked to ad here to redistribute income this could be via higher taxation on the rich to gain that money and then to redistribute it via income

Top-ups for the poor so it could be to reduce income inequality in society and another reason would be maybe to reduce the current account deficit so if ad is reduced because of contractionary fiscal policy incomes will be lower in the economy and therefore they’ll be less sucking and in imports less sucking in of imports going on so less expenditure on imports

And ceteris paribus that will reduce a current account deficit a trade deficit basically okay now let’s go into more detail with expansionary fiscal policy i’m going to focus now on this side of fiscal policy there is a video later in this playlist where i go into detail about contractionary fiscal policy the actual policies are there’s going to be the opposite

Of these i talk about but the pros and cons of contractionary fiscal policies discuss in detail later so watch that video if you want to see that side of the coin alright let’s look at expansionary fiscal policy examples so we can see that all of these policies will aim to boost aggregate demand and if we go to our diagram that i’ve drawn we can see the increase in

Ad that expansionary fiscal policy aims to bring about and from this diagram we can see the effects that i’ve already talked about here in blue we can see the higher economic growth from y1 to y2 the reduction and unemployment linked to that increase in economic growth we can see the higher demand pull inflation airy pressure as well but can you also see that i’ve

Had it on the multiplier effect and that’s something you can always talk about when we bring in the idea of expansionary fiscal policy and that’s the notion that an increase in aggregate demand will lead to higher incomes in the economy that will lead to more spending which is more ad and more incomes and more spending we’re going to this virtuous cycle of spending

In income spending in incomes right and therefore the end result is an even higher increase in ad and economic growth at y3 as opposed to y2 so we can link the multiplier to our expansionary fiscal policies but the policies themselves let’s focus on the tax policies we could have a rig duck and income tax the government could cut income tax now we’ve learned about

Progressive income tax systems so we can be far more precise than just saying that so it could be a cut in income tax for those in the higher income tax brackets it could be a reduction in income tax rates for those on the lower income tax brackets it could be a widening of the tax-free allowance it could be a widening of the tax band so we can be very precise in

What we mean by an income tax cut but in theory what that will do it will increase disposable income of households in the economy that will increase the marginal propensity for them to consume and therefore increase consumption in the ada equation and boost ad that way we could see a reduction of corporation tax the different tax here might be cut corporation tax

Is a tax on business profit so if corporation tax is cut that’s gonna increase retained profit for businesses that could increase their marginal propensity to invest increase investment in the ada equation a boost ad that way we could also see if stick with tax policies a reduction in a regressive taxation maybe that’s another one we can write down so for example

A reduction v80 regressive taxes burden the poor more than they do the rich they take a greater proportion of the income of the poor then they do of the rich as we’ve learned in my prior video and therefore if a regressive tax like v.a.t.s car it could increase disposable income for the poor more than for the rich and because the poor have a very high marginal

Propensity to consume it could boost consumption an ad that way but also we look at the government spending side of fiscal policy government spending could rise very simply on health care on education on infrastructure on public sector wages so always be precise with a form of government spending and that can boost g in the ada equation and therefore boost ad as

Well but even though fiscal policy is a demand side policy very much it is it will also have a link to l rs certain policies could also boost long-run aggregate supply and therefore boost the productive potential of the economy this is not the intention of expansionary fiscal policy the intention is to boost ad but this could very much be a side effect so you learn

This as a side effect not as an intention of expansion area fiscal policy so here i’ve drawn a diagram of lr a shifting to the right and we can see the increase in the productive potential of the economy potential growth from why if you want to why fe to the same policies i’ve already mentioned could also boost el ras as a side effect a reduction in income tax

What that could do is that can incentivize the inactive in the population to become active are you those outside the labor force to end to the labor force and that could increase the quantity of labor and boost the lrs but also for those in work if income tax is cut there is an incentive for them to work harder be more productive earn more because they can keep

More of their income as disposable income and if that happens productivity of labor goes up that’s an increase in the quality of labor boosting lra s if corporation taxes cut we said it’s gonna boost investment in therefore boost ad but we also know that investment also boosts lrs via an increase in the quantity and quality of capital but also via an improvement

In productive efficiency in the economy and also increases in government spending if we are more precise if it’s government spending on education health that could boost the productivity of labor and therefore boost the quality of labor and increased lra s but also increases in government spending on infrastructure can increase the productive efficiency in the

Economy also potentially boost the quantity of capital as well so there are links to lra s as well but remember the primary focus of fiscal policy expansion in fiscal policy is to boost aggregate demand this is purely a side effect so that’s good enough for this video guys we’ll leave it there i’m gonna go into far more detail on my next video looking at the issues

Of expansionary fiscal policy and some key evaluation points as well make sure you watch that video i’ll see you there thanks for watching

Transcribed from video
Y1 29) Fiscal Policy – Government Spending and Taxation By EconplusDal