Econs Strengths & Weaknesses Diagram
Strengths of Fiscal Policy
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Fiscal Policy is direct.
- Changes can be made very quickly if they need to be. <<<<<<< HEAD:content/Fiscal Policy/Book Notes/L6 - Strengths & Weaknesses of Fiscal Policy.md
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Can target specific economic sectors.
- #econs-example E.g. we targeted the airline industry with Fiscal Policy when they had reduced profits due to Exogenous Factors.
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Consumers immediatly feel the impact of Fiscal Policy changes.
- Government can pass a law and immediatly influence consumers in the short-term
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Can Affect Aggregate Supply
- e.g. Stimulus on Infrastructure Projects
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#econs-example E.g. the treasurer announces a increase in the excise tax rate on a commodity immediatly aftter the budget.
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#econs-example A Reduction in marginal rates of taxation after a arbitrary date. =======
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#econs-example E.g. the treasurer announces a increase in the excise tax rate on a commodity immediatly aftter the budget.
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#econs-example A Reduction in marginal rates of taxation after a arbitrary date.
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Consumers immediatly feel the impact of Fiscal Policy changes.
- Government can pass a law and immediatly influence consumers in the short-term
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Can target specific economic sectors.
- #econs-example E.g. we targeted the airline industry with Fiscal Policy when they had reduced profits due to Exogenous Factors.
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Can Affect Aggregate Supply
- e.g. Stimulus on Infrastructure Projects
f53a0af859096926d51bde64caa54f2466ccd128:content/Economics/Year 12/Fiscal Policy/Book Notes/L6 - Strengths & Weaknesses of Fiscal Policy.md
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Low Effect Lag
Fiscal Policy helps the economy during a recession. Government can open a ”spending tap”, artificially increasing the level of aggregate demand.
- #econs-example In the 1930s government funds helped to build infrastructure, thus employing workers. Providing immediate boost to employment, spending power, and consumption.
- #econs-example During the GFC, governments provided stimulus packages to avoid recession.
- #econs-example COVID-19 saw governments providing stimulus to avoid recession Well timed fiscal policy measures combined with Automatic Stabilisers help to dam-=pen booms, and in a downturn help to stimulate economic activity
Weaknesses of Fiscal Policy
Time Lag / Decision Lag
- Decision Lag is the lag between Economic Indicator and the Fiscal Response
- Recognitition Lag - The lag between recognitition of the trend from random fluctuations
Inflexible
It is difficult to deviate from previous budget trends.
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they are passed as legislation in may.
- Can not be adjusted afterwards
- Can only be slightly altered in Nov-Jan
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Treasury cannot make large changes to Allocative, or Redistributive patterns. Social, Demographic, and political constraints determine the “Fabric of the budget” (the Composition of the Budget) For example;
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We Cannot cut all defence spending to fix the economy
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Government cannot cut all social security pyments
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Government cannot massively increase social security benefits
- Funding larger benefits would be hugely expensive / could discourage labour
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Government cannot increase and decrease tax willy nilly as it could impact future Consumer & Business confidence.
Costs of Compliance
The Government must consider the costs of compliance in policy decisions, otherwise changes could put undue presure on businesses.
Political Constraints
Since governments seek re-election, when approaching an election;
- Governments may bias towards Expansioanry Budget.
- In an attempt to “buy” votes preceding an election
- #econs-example In May 2022, The Teasurer delivered an expansionary budge t prior to an election in october, the new government announced a budget that limited expenditure growth in order to bring down the deficit. Data used to compile Figure 12.1 and Figure 12.7 refer to that budget.
Crowding out
availability of oans explmnation Refers to the hypothesis that, during a deficit, the Private Sector can not help in the recoverty since the “cost of borrowing” is higher (High Interest Rate), as well as the tightening of the supply of loanable funds. Thus; Firms can’t help i nthe recovery because
- The availability of loanable money falls#ask_davis << tf that mean
- The Price of loanable money rises
- The risk of borrowing increases
- This is also refered to as a change in the “opportunity cost” of borrowing, where Capital Investment is not as profitable in comparison to risk.
- Risk of crowding out becoming a ”Zero-sum game”
- Increased Government Expenditure >
- Decreased Private Sector Activity
- Causing no-effect on the economy
Conflicting Policy Approaches
Generally, Fiscal & Monetary Policy should not contradict one another.
#econs-example TLDR; Increased Interest Rate & Decreased Taxes (tax cuts) at the same time.
In 2003 and 2007, there was an increase in Interest Rates, (Monetary Policy). Simultaneously there where tax cuts. All during a booming economy.
The government stated it was to “return some of the surplus to taxpayers and to focus on long-term structural reforms to the economy”
How Fiscal Policy affects the Supply Curve
- Spending on infrastructure
- The impact of income tax rates
Recent Fiscal Policy
Quote Fiscal Policy - Budget Outcome
(Source)
As seen above, every time there is a significant economic recession
- A Large Budget Deficit Occurs
This occured due to Automatic Stabilisers that pushed the Cyclical Component of the budget towards surplus.
It was not a result of an increase in discretionary policy Discretionary Policy / The Structural Component of the budget remained in deficit
In the post-GFC period, we saw the Structural Component go further into deficit as structural measures induced in response to the crisis pushed it further down;
- Reducing the tax burden for small businesses
- Further G1 Welfare Spending, Further Deficit
- Funding Transport Infrastructure
- Further G1 Infra Spending, Further deficit
- Amendments to education & health funding
- (Increased G2 Spending in the long-term?)
- Changing Income Tax brackets
- Occured in 2017 Budget#add_to_trends
- Commitments to reduce company taxation.