The Impact of Fiscal Policy on Macroeconomic Objectives (Edexcel IGCSE Economics)
Exam board Pearson Edexcel · IGCSEUpdated 2024-06-21
The Goals of Fiscal Policy
Spec point —
2.1.2a
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Fiscal policy is used to help the government achieve their macroeconomic objectives
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Specifically, the use of fiscal policy aims to achieve:
- Economic growth
- A low and stable rate of inflation
- Maintain low unemployment
- Redistribute income
- Current account stability
- Environmental protection
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When a policy decision is made, it creates a ripple effect through the economy, impacting the macroeconomic objectives of the government
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Expansionary fiscal policy is used to stimulate growth and create employment
- This can lead to higher tax revenues, which can be used to redistribute income
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Contractionary fiscal policy is used to tackle inflationary pressures
- This may have the side effect of reducing growth and increasing unemployment
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Expansionary Fiscal Policies and Macroeconomic Objectives
Spec point —
2.1.2a
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Expansionary fiscal policies involves decreasing taxes and/or increasing government spending
- The aim is to grow the economy
Explaining the Impact of Expansionary Fiscal Policy
| Example 1: The Government decreases corporation tax | |
|---|---|
| Effect on the economy | - The net profit of firms increases → investment by firms increases → output of the economy expands → more workers are required income per capita increases |
| Impact on macroeconomic aims | - Economic growth increases - Inflation rises due to increased short-term investment spending - Unemployment may decrease as output rises, which requires more workers - Current account: exports may increase due to new investments leading to better quality output, but imports may also rise due to higher income households buying imports - There may be more damage to the environment as industrial output increases |
| Example 2: The Government increases spending on infrastructure | |
|---|---|
| Effect on the economy | - More building firms employ workers → household income increases → consumption increases |
| Impact on macroeconomic aims | - Economic growth increases - Inflation pressures rise - Unemployment may decrease as construction employers hire more workers - The current account deficit may worsen as households spend more on imports |
Contractionary Fiscal Policies and Macroeconomic Objectives
Spec point —
2.1.2a
- Contractionary fiscal policies involves raising taxes or decreasing government spending
Examples of the Impact of Contractionary Fiscal Policy
| Example 1: The Government increases the rate of income tax | |
|---|---|
| Effect on the economy | - Households pay more tax → discretionary income reduces → consumption reduces → the pace of economic growth slows down |
| Impact on macroeconomic aims | - Economic growth slows down - Inflation eases - Unemployment may increase as output is falling and fewer workers are required - A current account surplus may occur if households purchase less from abroad (imports) - Environmental protection improves as economic growth slows down |
| Example 2: The Government freezes or reduces the pay of public sector workers | |
|---|---|
| Effect on the economy | - Public sector wages stagnate or reduce → consumer confidence falls → consumption decreases |
| Impact on macroeconomic aims | - Economic growth slows down - Inflation eases - Unemployment may increase as output falls - The current account may improve as households spend less on imports |
| Example 3: The Government cuts spending in the budget | |
|---|---|
| Effect on the economy | - There is less government demand for goods and services → less income for firms → output and profits decrease |
| Impact on macroeconomic aims | - Economic growth slows down - Inflation eases - Unemployment may increase as output falls - Less corporation tax is available for redistribution - A current account surplus may occur if imports are reduced - Environmental damage may fall as the level of output in the economy falls |
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