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Using fiscal policy to manage the economy
M acroeconomic problem Hi gh unem pl oym ent D emand management fiscal policy (short run) D ecrease rate ofi ndi rect taxes. Thi swi l lcause an i ncrease i n consum pti on,assum i ng a hi gh M PC and hi gh expectati ons,due to i ncreased di sposabl ei ncom e. D ecrease the rate ofdi rect taxes. Thi si sl i kel y to cause the sam e ef f ects as decreasi ng i ndi rect taxes but i sl i kel y to have a greater i m pact. I ncrease di screti onalgovernm ent spendi ng; both current and capi tal . Supply-side fiscal policy (long run) I ncrease di screti onalcapi talgovernm ent expendi ture,f or exam pl e oftrai ni ng f or the unem pl oyed. Thi swi l li ncrease occupati onal m obi l i ty and so l ow er the naturalrate of unem pl oym ent i n the econom y. Reduce w el f are paym ents to reduce di si ncenti ves to w ork and so i ncrease parti ci pati on i n the w ork f orce,thus i ncreasi ng aggregate suppl y. Problems Low grow th General l y SR f i scalpol i cy has a very l i mi ted ef f ect on LR grow th. D ecrease rate ofi ndi rect taxes. Thi swi l lcause an i ncrease i n consum pti on,assum i ng a hi gh M PC and hi gh expectati ons,due to i ncreased di sposabl ei ncom e. D ecrease the rate ofdi rect taxes. Thi si sl i kel y to cause the sam e ef f ects as decreasi ng i ndi rect taxes but i sl i kel y to have a greater i m pact. I ncrease governm ent spendi ng on subsi di si ng i nvestm ent by f i rm s. I n the short run thi swi l l i ncrease A D ,and i n the l ong run thi swi l l i ncrease A S. I ncrease i ndi rect and di rect rates oftaxes to decrease di sposabl ei ncom e and so decrease consum pti on w i thi n the econom y. D ecrease di screti onalgovernm ent spendi ng. I ncrease i ndi rect and di rect rates oftaxes to decrease di sposabl ei ncom e. Thi swi l l decrease spendi ng on l uxury goods,w hi ch are i m ports. D i rect taxes are descri bed as a bl unti nstrum ent as they have a l arge ef f ect but af f ect the enti re econom y,not j ust the target. I ncrease tari f f s( tax on i m ported goods)to m ake i m ports l ess attracti ve,so U K consum ers by U K produced goods and servi ces. Thi si s cal l ed an expendi ture sw i tchi ng pol i cy. I ncrease di screti onalcapi talgovernm ent expendi ture,f or exam pl e oftrai ni ng f or the unem pl oyed. Thi swi l li ncrease occupati onal m obi l i ty and so l ow er the naturalrate of unem pl oym ent i n the econom y. Low eri ng the l ow er rates ofdi rect tax as i n the LR thi s shoul di ncrease parti ci pati on by decreasi ng di si ncenti ves to w ork. Low eri ng the hi gher rates oftax shoul d,to a l i mi ted degree encourage entrepreneurshi pwi thi n the econom y. I ncrease governm ent spendi ng on trai ni ng and educati on to: o I ncrease parti ci pati on o I ncrease m obi l i ty o I ncrease producti vi ty I m pl em ent l ong run econom i c grow th pol i ci es to shi f t the aggregate suppl y curve outw ards. I ncrease i ncenti ves f or i nvestm ent and governm ent expendi ture. M ake exports m ore com peti ti ve by: o Subsi di si ng pri vate i nvestm ent i n research and devel opm ent o Governm ent spendi ng on research and devel opm ent,educati on and i nf rastructure. I nf l ati on i s caused as resources becom e scarcer as em pl oym ent i ncreases that i s as the LRA S curve becom es m ore i nel asti c. Ti m el ags and the m ul ti pl i er m ay w orsen the ef f ects of i nf l ati on. The econom y m ay be near the rate ofnatural unem pl oym ent and so proporti onal l y hi gh i nf l ati on w i l lbe suf f ered f or an i ncrease i n em pl oym ent. A rguabl y governm ent capi talexpendi ture i s al l ocated l ess ef f i ci entl y than pri vate capi talexpendi ture,as governm ents m ay have goal s other than ef f i ci ency. Conf l i ct ofdecreased taxes and hi gher governm ent spendi ng. I nf l ati on as resources becom e scarcer and as em pl oym ent i ncreases. The ef f i ci ency ofcapi talspendi ng by the governm ent i s debateabl e. M any argue that governm ent spendi ng crow ds outm ore ef f i ci ent pri vate i nvestm ent as the governm ent has goal s other than ef f i ci ency. Conf l i ct ofdecreased taxes and hi gher governm ent spendi ng.

Hi gh i nf l ati on

Bal ance of paym ents def i ci t

Low er aggregate dem and i n the short run causes hi gher unem pl oym ent i n the short run. Hi gher corporati on tax i sl i kel y to cause a decrease i n i nvestm ent so m ay cause a l ong run probl em . Tari f f s not ef f ecti ve i fdem and f or i m ports i s pri ce i nel asti c ( w hi ch i s true ofthe U K) .Of ten there i s no U K substi tute f or a good or servi ce and som eti m es there i s no EU substi tute. Tari f f s m ake f or pol i ti caldi f f i cul ti es and are i l l egalw i thi n the EU and EPTA .