Fiscal Policy

A-level Economics

Government demand-side and supply-side policies

Fiscal policy involves the use of government spending and taxation

Definition: Fiscal policy is the control of government spending and taxation to influence the level of aggregate demand and supply in the economy.

What is the budget?

The budget is the available revenue available for the government to spend on public services and running the country.

The budget can be either in deficit or surplus.

A budget deficit exists when government outgoings are greater than their income.

A budget surplus exists when government outgoings are lower than their income.

How does the state of the government budget affect the economy? When and how do we use fiscal policy?

If the government is in a budget deficit, then it means the government is spending more and receiving less tax. What sort of effect will this have on the economy? It will mean that there are net injections into the economy from the government. The economy is likely to grow due to this increased spending. It can also trigger off the multiplier effect. This type of policy is called expansionary fiscal policy.

A budget deficit is likely to be used in a state of economic recession or recovery. This is because the government has to ensure that economy is able to grow and recover from the previous economic slump.

Conversely, a budget surplus will be used in an economic boom. This is because spending in the economy is already too high - the government needs to raises taxation revenue and reduce spending so the economy's spending does not overheat and get out of control. Therefore, in a boom, the government should be employing contractionary fiscal policy.

Is Fiscal Policy only a demand-side policy?

Fiscal policy is different because fiscal policy has demand-side and supply-side effects. If a government injects money into the economy by hiring firms to build new roads and infrastructure, the money used will be an injection into the circular flow of income (demand-side). However, the new infrastructure that has been built with government money will have supply-side benefits by boosting productive potential.

This is a key advantage fiscal policy has over monetary policy.

What have we learned.