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Fiscal Policy

Fiscal Policy refers to Government's use of spending and taxation, referred as supply
side effects.


Taxes I Savings I Investment Capital I Real GDP I Ricardo Barro effect refers to increase in fiscal deficit shall cause higher taxes in future.



Sources of investment financing

  • National savings
  • Borrowing from foreigners
  • Government savings

The crowding-out effect occurs when budget deficits (negative Govt. saving) caused by expansionary fiscal policy lead to higher interest rates & lower private investment.


Importance of Timing in Fiscal Policy

      Recognition Delay: Time it takes policy to recognize that a policy change is necessary.

      Administrative or law making delay: Time lag b/w recognition & final passage of law or policy change.

      Impact delay: Time lag b/w passage of the law or policy & when its impact is felt in the economy.


 Fiscal Multiplier & factor affecting fiscal Multiplier


When government expenditures increases, aggregate demand & GDP increases by some multiple, as wages & payments received by workers & capital owners lead to future increases in aggregate expenditures. This is referred to as the expenditures (Govt. purchases) multiplier.


o   Government purchases multiplier: A dollar of government spending causes more than a $1 increase in aggregate demand.


o   Tax multiplier: Tax cuts also have magnified effects on aggregate demand, less than government purchases as some of the tax is saved.


o   Balanced budget multiplier: Combined program of government purchases & taxes, an increase in spending and equal increase in taxes will have a stronger positive effect on aggregate demand.


Generational effects of Fiscal policy

The difference b/w the PV of future benefits promised to voters (such as Medicare insurance in the  US) & the currently collected taxes is referred to as a generational imbalance.

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