Thursday, 6 October 2011

Fiscal Policy (Macroeconomics)

Right, this post will discuss the basics of fiscal policy. Basically, fiscal policies are any policies that relate to government spending and government taxation - the government uses these two tools to manage the economy and redistribute resources.

The budget plays a big part in fiscal policies. Depending on what fiscal policies have been employed by the government depend on the position of the budget. If the government spends more than it receives through tax receipts then it will have a budget deficit. If it receives more than it spends then there will be a budget surplus.Two other terms that come about when talking about the budget are the following:

  • Public Sector Net Cash Requirement (or PSBR) - This is an account of how much the government has to borrow in order to balance the budget.
  • Public Sector Debt Repayment (or PSDR) - This is when the budget is in surplus and the government can pay back some loans.

When using taxation as a fiscal policy, the government can change the rates of direct taxation or indirect taxation. Direct is tax paid straight from the income, wealth or profit of individuals or firms (income tax or corporation tax). Indirect is tax paid on goods and services (VAT or council tax).

The effects of fiscal policies are as follows, generally:
  • A rise in taxes / a cut in government spending leads to a fall in aggregate demand.
  • A cut in taxes / a rise in government spending leads to a rise in aggregate demand.

Now for the rules. "The Golden Rule" is a rule relating to the Labour parties thoughts that fiscal policy should be stable and consistent. This rule states that tax receipts should cover all government spending and that borrowing by the government should only be done for investment purposes. This rule applies over an economic cycle, not on an annual basis.

Another rule is the "Sustainable Rule". This states that government debt should be kept at a stale level. This means that debt shouldn't rise above 40% of GDP, this target is to be met every year.

Fiscal policy basics complete. Thanks. 

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