Fiscal Policy

Fiscal Policy

These taxing and spending decisions by the government are set out in the Budget.

Fiscal Policy : Taxing and spending by the government to influence the level of economic activity

Taxation Spending

Government Income Comes mainly from Taxation (T) also some profit

from State Owned Enterprises (SOE)

Taxation is both Direct ( Income tax, PAYE)Indirect ( Goods and services tax, GST)

When designing a tax system to raise revenue the government must take into accountThe DWL cost of the tax ( When it can cost more to

raise the tax than it gains)Compliance costs ( Cost of filling in GST returns in

time and wages) Tax systems in nearby countries. If tax is less un

Australia then people will move and Governments tax take will fall.

Government Expenditure Government expenditure (G) is an injection into the

circular flow. It includes spending on Wages and salaries of government employeesCapital e.g. HospitalsTransfers e.g. Welfare payments

Government Spending in the Budget is always bigger than the figure in GDP calculations because the budget include transfers where the GDP calculation takes the Net effect of Tax – Transfers ( T- TR)

Government spending has generally decreased as a percentage of GDP over the last few years to around 30%

The Budget 2003 – 2004 Make three statements about the governments budget in 2003 – 2004 in 3mins.

Governments Operating Balance

Tax- leakage from circular flowSpending- injection into

circular flow

When tax=spending there is no increase in GDP (Balanced Budget). Operating Balance is zero

Contractionary Fiscal Policy When tax > spending Govt. is running a budget

surplus…called contractionary fiscal policy.

This Causes a primary contraction of the money supply that leads to a secondary contraction

Expansionary Fiscal Policy When tax < spending… Govt. is running a

budget deficit… called expansionary fiscal policy.

Govt. uses expansionary fiscal policy when spending is down (usually in times of recession)to keep growth in positives.

Fiscal PolicyHistory of fiscal policies

Often used expansionary policies 1930s govt acted to drag the economy out of

depressionThink big projects of 1970s and 1980s meant

to reduce NZ dependence on overseas oil and create 400,000 jobs. Pushed up govt spending and did not create as many jobs as hoped.

Fiscal Responsibility Act 1994: aimed at running budget surpluses therefore CONTRACTIONARY in nature (enables debt to be paid off)

Expansionary Fiscal Policy If the government does decide to increase its

spending the money needs to come from somewhereIf the money comes from the RBNZ then it can be

inflationary, as it increases deposits with banks and causes a secondary expansion of credit. This increases the money supply and the deficit is said to be monetised

Borrow from the public or overseas. Done by selling government bonds. Money demand will increase This will mean interest rates will rise.