Fiscal PolicyDr Akhlas Ahmed

Lecture # 4 @IBT City campus, Karachi

06.02.2017

Fiscal and monetary policy are two major drivers of a nation’s economic performance.

Through monetary policy, a country’s central bank influences the money supply.

Through fiscal policy, regulators attempt to improve unemployment rates, control inflation, stabilize business cycles and influence interest rates in an effort to control the economy.

Regulators use both policies to try to boost a flagging economy, maintain a strong economy or cool off an overheated economy.

What is ‘Fiscal Policy’?Government spending policies that influencemacroeconomic conditions.

• Fiscal policy is largely based on the ideas of British economist John Maynard Keynes (1883–1946), who believed governments could change economic performance by adjusting tax rates and government spending.

• Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply.

• Fiscal policy refers to the Revenue and Expenditure policy of the Govt. which is generally used to cure recession and maintain economic stability in the country.

• Why is the Fiscal Policy important?• Fiscal policy is important because it regulates

government spending and taxation. • Fiscal policy controls decisions made at the

local, national and federal government levels, such as goods, services and products purchased, appropriate levels of taxation and government financial programs.

• Who enacts the fiscal policy?• Expansionary Fiscal Policy – • Policy enacted by the government that

increases output. • Examples include lowering taxes and

increasing government spending. • Expansionary Monetary Policy – • Policy enacted by the Fed that increases the

money supply and thus increases output.

• Which is an example of fiscal policy?• The two major examples of expansionary

fiscal policy are tax cuts and increased government spending. Both of these policies increase aggregate demand while contributing to deficits or drawing down of budget surpluses.

• Is our fiscal policy tight or lose?• Fiscal policy is the use of government spending

and taxation to influence the economy. ... Fiscal policy is said to be tight or contraction when revenue is higher than spending (i.e., the government budget is in surplus) and loose or expansionary when spending is higher than revenue (i.e., the budget is in deficit).

• Instruments of Fiscal Policy…• 1. Reduction of Govt. Expenditure• 2. Increase in Taxation• 3. Imposition of new Taxes• 4. Wage Control• 5.Rationing• 6. Public Debt• 7. Increase in savings• 8. Maintaining Surplus Budget

• Other Measures…• 1. Increase in Imports of Raw materials• 2. Decrease in Exports• 3. Increase in Productivity• 4. Provision of Subsidies• 5. Use of Latest Technology• 6. Rational Industrial Policy

How is the Monetary Policy different from the Fiscal Policy?

• The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks.

• The Monetary Policy aims to maintain price stability, full employment and economic growth.

• The Monetary Policy is different from Fiscal Policy as the former brings about a change in the economy by changing money supply and interest rate.

• Whereas fiscal policy is a broader tool with the government.

• The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices.

How the government could try to use fiscal policy to affect the

economy? Consider an economy that’s

experiencing a recession.

Case study # 1: The government might lower tax rates to try to fuel economic growth. If people are paying less in taxes, they have more money to spend or invest. Increased consumer spending or investment could improve economic growth. Regulators don’t want to see too great of a spending increase though, as this could increase inflation.

Case study # 2: Another possibility is that the government might decide to increase its own spending – say, by building more highways. The idea is that the additional government spending creates jobs and lowers the unemployment rate. Some economists, however, dispute the notion that governments can create jobs, because government obtains all of its money from taxation – in other words, from the productive activities of the private sector.

One of the many problems with fiscal policy is that it tends to affect particular groups disproportionately.

A tax decrease might not be applied to taxpayers at all income levels, or some groups might see larger decreases than others.

Likewise, an increase in government spending will have the biggest influence on the group that is receiving that spending, which in the case of highway spending would be construction workers.

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply. These two policies are used in various combinations to direct a country's economic goals. Here we look at how fiscal policy works, how it must be monitored and how its implementation may affect different people in an economy.

Before the Great Depression, which lasted from Sept. 4, 1929 to the late 1930s or early 1940s, the government's approach to the economy was laissez-faire.

Following World War II, it was determined that the government had to take a proactive role in the economy to regulate unemployment, business cycles, inflation and the cost of money.

By using a mix of monetary and fiscal policies (depending on the political orientations and the philosophies of those in power at a particular time, one policy may dominate over another), governments are able to control economic phenomena.

How Fiscal Policy WorksFiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when between 2-3%), increases employment and maintains a healthy value of money. Fiscal policy is very important to the economy. For example, in 2012 many worried that the fiscal cliff, a simultaneous increase in tax rates and cuts in government spending set to occur in January 2013, would send the U.S. economy back to recession. The U.S. Congress avoided this problem by passing the American Taxpayer Relief Act of 2012 on Jan. 1, 2013.

Class activity:Talk about fiscal and Monterey policy…Time limit: 05 minutes each.

QUIZ # 4 (6.2.17)Q1. How you describe the fiscal policy of Pakistan?

Assignment # 4Q1. Make a chart and compare fiscal policy with monetary policy.