7. Fiscal Policy: Roles, Objectives, and Tools

o. describe roles and objectives of fiscal policy;

p. describe tools of fiscal policy, including their advantages and disadvantages;

q. describe the arguments about whether the size of a national debt relative to GDP matters;

What is fiscal policy?
Fiscal policy refers to the use of government expenditure, tax, and borrowing activities to achieve economic goals. Including
- the overall level of aggregate demand in an economy (and hence the level of economic activity),
- the distribution of income and wealth among different segments of the population, and, ultimately,
- the allocation of resources between different sectors and economic agents.

How does a government generate revenues?
Taxes

What is the difference between a budget and a balanced budget?
A budget is the annual statement of the government's expenditures and tax revenues. A balanced budget implies that current government revenue is equal to current government expenditures.

What is a budget deficit and/or surplus?
- A budget deficit exists when total government spending exceeds government revenue.
- A budget surplus occurs when revenues exceed spending.

What are some arguments against being concerned with the size of a fiscal deficit?
- The debt is owned internally by fellow citizens
- Some borrowed money may have been used for capital investment projects or enhancing human capital.
- Large deficits require tax changes which may be desirable.
- Richardian equivalence: the timing of any tax change does not affect consumers' change in spending.
- Debt could improve employment.

What are some arguments for being concerned about national debt?
- Higher deficits -> higher tax rates -> less incentive to work and invest -> lower long-term growth
- The central bank may have to print money to finance a deficit. This may lead to high inflation.

What is the marginal propensity to consume and marginal propensity to save? What's the math?
- As disposable income increases, consumption expenditures increase, but by a smaller fraction than the increase in income.
- Marginal propensity to consume (MPC) and Marginal propensity to save (MPS) combine to 1
- MPC + MPS = 1 - t
- t = tax rate

Source:

• CFA