Macroeconomic PoliciesMacroeconomic Policies

Fiscal PoliciesFiscal Policies

Macroeconomic Policies

conditions necessary for ideal economic efficiency

Economic efficiency: for any given level of effort (cost), we want to obtain the largest possible benefit. i.e., getting the most value from your available resources.

1. Undertaking an economic action will be efficient if it produces more benefits than costs.

2. Undertaking an economic action will be inefficient if it produces more costs than benefits.

Why is government necessary to an economy?

• Both failure to undertake an efficient action (rule 1) and the undertaking of inefficient activities (rule 2) will result in economy inefficiency.

• Government, especially through fiscal policy actions, serves to police these two economic rules of efficiency and hopefully bring about a compromise.

Fiscal Policy

• Influencing the level of economic activity though manipulation of government income and expenditure

• Associated with Keynesian Demand Management Policies

Fiscal Policy

In wider terms:• Influences Aggregate Demand –

– Tax level influences consumption (C) and investment (I)

– Government Spending (G)

• Influences key economic objectives• Acts as an ‘automatic stabiliser’

Fiscal Policy

BUT:• Also used to influence non-

economic objectives• e.g. education and health, poverty

reduction, welfare reform, investment, regional policies, etc.

Government Income

• Tax Revenue• Sale of Government Services – e.g.

passports, Queen’s Printer, etc.• Borrowing (e.g., Canada Savings

Bonds)

Government Income (UK) – Inland Revenue 2002-2003

Source: http://www.hm-treasury.gov.uk/media//E3CCB/PublicFinancesDatabank280104.XLS

52%

1%

13%

29%

0%

1%1%

3%Income Tax (gross of Tax Credits)

Income Tax Credits

Corporation Tax

NICs

Petroleum revenue Tax

Capital Gains Tax

Inheritance Tax

Stamp Duties

Government Expenditure

• Social Security• Law and Order• Emergency

Services• Health• Education• Defence• Foreign Aid

• Environmental Protection

• Agriculture• Industry• Transport• Regional Support• Culture, Media

and Sport

Fiscal Policy In Action

Inflation

Real National Income

AS

AD

2.0%

U=5%

Assume an initial equilibrium position with a level of National Income giving an unemployment rate of 5% (U = 5%)

If government ‘reduces taxes’ (remember the subtleties) and or increases spending, it will have various effects:

AD=C+I+G+(X-M)

Apart from G, C and I are also likely to be affected directly or indirectly by the policy change.

AD 1

AD therefore shifts to the right to AD1

2.5%

U=3%

The rise in AD leads to an increase in real national income, ceteris paribus, unemployment would fall to 3% but at a cost of higher inflation