Fiscal Policy
Fiscal Policy
Fiscal Policy : Taxing and spending by the government
to influence the level of economic activity
Taxation
Spending
 These taxing and spending decisions by the government are
set out in the Budget.
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 account
 The 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 employees
 Capital e.g. Hospitals
 Transfers 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 flow
 Spending- 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 Policy
 History of fiscal policies
 Often used expansionary policies
 1930s govt acted to drag the economy out of depression
 Think 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 somewhere
 If 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.