The effectiveness of fiscal policies depends on the particular economy, and there is debate over whether particular tools are helpful: • Keynesians believe that fiscal policy is effective in affecting aggregate demand. • Monetarists believe that fiscal policy effectiveness is only temporary. Government receipts are generally taxes on income and taxes on goods and services. Fiscal policy examples: • Expansionary fiscal policy: Increase spending • Contractionary fiscal policy: Increase taxes COPYRIGHT © 2014 CFA INSTITUTE 66
Budget surplus/debt A budget surplus exists if government revenues exceed government spending. A budget deficit exists if government revenues are less than government spending. Automatic stabilizers are self-correcting mechanisms. • Examples: ◦ In a downturn, government transfer payments increase (for example, unemployment benefits). ◦ In a booming economy, taxes increase (especially if progressive). • These stabilizers may exaggerate or exacerbate fiscal policies if not taken into account by the government. The national debt of a country increases with government deficits. • At some point, a nation will be considered insolvent.3 COPYRIGHT © 2014 CFA INSTITUTE 67
Issue: Concern about national debt? Reasons why concerns regarding national debt may be overblown: . Much of a nation’s debt is owed internally. Some of the debt may have been incurred to finance capital projects or to enhance human capital, which should contribute to the growth of the economy. Large deficits may encourage changes in tax laws, which may contain distortions. Private sector saving may increase. If there is unemployment, debt is not taking funds from productive uses. National debt as a major concern: A high debt-to-GDP ratio may lead to higher taxes and hence disincentives. Lack of confidence in the government may exist, making some policies ineffective. Government borrowing diverts funds from more productive uses (referred to as crowding out ). COPYRIGHT © 2014 CFA INSTITUTE 68
Fiscal policy tools Fiscal policy tools include • transfer payments, such as welfare and social security • current government spending on goods and services • capital expenditures (e.g., spending on infrastructure) Government spending may be justified on economic and social grounds. Government revenues include • direct taxes, including income taxes. • indirect taxes, such as excise duties and taxes on gambling income. Taxes generate government revenues and may be used for income redistribution. • Desirable properties of a tax policy are simplicity, efficiency, fairness, and revenue sufficiency. COPYRIGHT © 2014 CFA INSTITUTE 69
Fiscal policy tools Advantages of fiscal policy tools Indirect taxes can be adjusted quickly. Social policies can be affected quickly using excise taxes (e.g., on tobacco).