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TABLE OF CONTENT
Introduction ................................................................................................................... 3
Definition of key terms ................................................................................................... 3-4
General Overview .......................................................................................................... 4-7
Bibliography ................................................................................................................... 7-8
Ministry: Greek Cabinet and Culture Ministry
Question of: Reforming Fiscal Policy
Chair: Sim Oya Uğuzman
Position: Deputy Chair
INTRODUCTION
Fiscal Policy is, by means, the combined governmental decisions regarding to a
country’s taxing and spending. It is the adjustment made by the government itself which
monitors and influences a nation’s economy. You may say that it is the sister strategy to
monetary policy through which a central bank influences a nation’s money supply. These two
policies are used in various combinations to direct a country’s economic goals. Through fiscal
policy, regulators attempt to improve unemployment rates, control inflation, stabilize business
cycle and influence interest rates in as effort to control the economy.
DEFINITION OF KEY TERMS
MONETARY POLICY: Monetary policy consist of the actions of a central bank, currency
board or other regulatory committee that determine the size and rate of growth of the money
supply, which in turn affects interest rates. Monetary policy maintained through actions such
as modifying the interest rate, buying or selling government bonds, and changing the amount
of money banks are required to keep in the vault (bank reserves).
THE GREAT DEPRESSION: The Great depression was a severe world-wide economic
depression that took place during the 1930s. The timing of the Great Depression varied across
nations; in most countries it started in 1929 and lasted until the late 1930s. It was the longest,
deepest and most widespread depression of the 20th century. In the 21st century, the Great
Depression is commonly used as an example of how far the world’s economy can decline.
CONSUMER SPENDING: Consumer spending is another term for voluntary consumptions,
or an exchange of money for goods and services. Contemporary measures of consumer
spending include all private purchases of durable goods, nondurables and services.
BUSINESS CYCLE: The business cycle is the fluctuation in economic activity that an
economy experiences over a period of time. A business cycle is basically defined in terms of
periods of expansion or recession.
AD (Aggregate Demand): AD is the total level of planned expenditure in an economy.
(AD = C + I + G + X – M)
FISCAL STANCE: Refers to whether the government is increasing AD or decreasing AD.
FINE TUNING: Involves maintaining a steady rate of economic growth through using fiscal
policy. However, this has proved quite difficult to achieve precisely.
AUTOMATIC FISCAL STABILISERS: If the economy is growing, people will
automatically pay more taxes (VAT and Income tax) and the government will spend less on
unemployment benefits.
GENERAL OVERVIEW
Fiscal policy involves the government changing the levels of taxation and government
spending in order to influence Aggregate Demand (AD) and the level of economic activity.
Fiscal policy is largely based on the ideas of British economist John Maynard Keynes
(1883-1946). Also known as Keynesian economics, this theory basically states that
government can influence macroeconomic productivity levels by increasing or decreasing tax
levels and public spending. This influence, in turn, curbs flatiron (generally considered to be
healthy when between 2-3%), increases employment and maintains a healthy value of money.
The idea, however, is to find a balance between changing tax rates and public spending.
For example, stimulating a stagnant economy by increasing spending or lowering taxes runs
the risk of causing inflation to rise. This is due to an increase in the amount of money in the
economy, followed by an increase in consumer demand, can result in a decrease in the value
of money – meaning that it would take more money to buy something that has not changed in
value.
The purposes of fiscal policy:
a. Stimulate economic growth in a period of a recession
b. Keep inflation low (UK government has a target of 2%)
c. Basically, fiscal policy aims to stabilize economic growth, avoiding a boom and bust
economic cycle.
Types of fiscal policy:
There are two types of fiscal policy. The first and most-widely used is expansionary fiscal
policy; and the other one is deflationary fiscal policy.
Expansionary (or loose) fiscal policy:



This involves increasing AD
Therefore the government will increase spending (G) and/or cut taxes (T). Lower taxes
will increase consumers spending because they have more disposal income (C)
This will tend worsen the government budget deficit and the government will need to
increase borrowing.
Deflationary (or tight) fiscal policy:



This involves decreasing AD
Therefore, the government will cut government spending (G) and/or increase taxes.
Higher taxes will reduce consumer spending (C)
Tight fiscal policy will tend to cause an improvement in the government budget
deficit.
Criticism of fiscal policy
The government may have poor information about the state of the economy and struggle to
have the best information about what the economy needs.
Time lags. To increase government spending will take time. It could take several months
for a government decision to filter through into the economy and actually affect AD. By then
it may be too late.
Crowding out. Some economists argue that expansionary fiscal policy (higher government
spending) will not increase AD, because the higher government spending will crowd out the
private sector. This is because government have to borrow from the private sector who will
then have lower funds for private investment.
Government spending is inefficient. Free market economists argue that higher government
spending will tend to be wasted on inefficient spending projects. Also, it can then be difficult
to reduce spending in the future because interest groups put political pressure on maintaining
stimulus spending as permanent.
Higher borrowing costs. Under certain conditions, expansionary fiscal policy can lead to
higher bond yields, increasing the cost of debt repayments.
Evaluation of fiscal policy
It depends;



on the size of the multiplier. If the multiplier effect is large, then changes in
government spending will have a bigger effect on overall demand.
on the state of the economy. Fiscal policy is most effective in a deep recession where
monetary policy is insufficient to boost demand. In a deep recession (liquidity trap).
Higher government spending will not cause crowding out because the private sector
saving has increased substantially. See: Liquidity trap and fiscal policy – why fiscal
policy is more important during a liquidity trap.
(For further information: http://economics.mit.edu/files/7558)
on other factors in the economy. For example, if the government pursue expansionary
fiscal policy, but interest rates rise and the global economy is in a recession, it may be
insufficient to boost demand.
Bond yields. If there is concern over the state of government finances, the government may
not be able to borrow to finance fiscal policy. Countries in the Eurozone experienced this
problem in the 2008-13 recession.
Brief history of fiscal policy
Keynes advocated the use of fiscal policy as a way to stimulate economies during the
great depression.
Fiscal Policy was particularly used in the 50s and 60s to stabilize economic cycles. These
policies were broadly referred to as ‘Keynesian’
In the 1970s and 80s governments tended to prefer monetary policy for influencing the
economy. Fiscal policy became more prominent during the great depression of 2008-13
Methods of funding:
Governments spend money on a wide variety of things, from the military and police to
services like education and healthcare, as well as transfer payments such as welfare benefits.
This expenditure can be funded in a number of different ways:
a.
b.
c.
d.
e.
Taxation
Seigniorage (the benefit of printing money)
Borrowing money from the population or from abroad
Consumption of fiscal reserves
Sale of fixed assets (e.g. land)
Fiscal Policy vs. Monetary Policy
Monetary policy is when a nation's central bank changes the money supply. It increases it
with expansionary monetary policy and decreases it with contractionary monetary policy. It
has many tools it can use, but it primarily relies on raising or lowering the Fed funds rate.
This benchmark rates then guides all interest rates. When interest rates are high, the money
supply contracts, the economy cools down, and inflation is prevented. When interest rates are
low, the money supply expands, the economy heats up, and a recession is usually avoided.
Monetary policy works faster than fiscal policy. The Fed can just vote to raise or lower
rates at its regularly FOMC meeting. It may take about six months for the impact of the rate
cut to percolate throughout the economy.
BIBLOGRAPHY

“Fiscal Policy Definition”, Investopedia,
https://www.inverstopedia.com/terms/f/fiscalpolicy.asp

“What is fiscal policy?”, Investopedia,
https://www.investopedia.com/articles/04/051904.asp

“Fiscal Policy”, Wikipedia https://en.wikipedia.org/wiki/Fiscal_policy

“Types of fiscal policy”, Economicshelp
https://www.economicshelp.org/macroeconomics/fiscal-policy/fiscal_policy/

“Fiscal policy: Types, objectives and tools”, thebalance, https://www.thebalance.com/what-
is-fiscal-policy-types-objectives-and-tools-3305844

“Funding, fiscal policy”, IMF, www.imf.org/external/pubs/ft/fandd/basics/fiscpol.htm

“What is fiscal policy”, Econlowdown, https://www.econlowdown.org/fiscal_policy

“Fiscal policy, definition, effects” Study.com, study.com/academy/lesson/what-isfiscal-policy-definition-effects-example.html