Question

What is fiscal policy and what are its purposes?

What is the Laffer curve?

What is the difference between discretionary fiscal policy and automatic fiscal policy?

What is the government expenditure multiplier?

What are some of the limitations of fiscal policy? Briey discuss them.

Answer 1

Question 1- What is fiscal policy and what are its purposes?

Answer1- Fiscal policy is defined as the use of government revenue and expenditure in order to influence the economy of the country. The purpose of the fiscal policy is to stabilize the economy over the course of the business cycle.

Question 2- What is the Laffer curve?

Answer 2- Laffer curve tells the relationship between the tax rates and the amount of tax revenue collected by the government. It is used to show that sometimes cutting tax rates can increase total tax revenue.

Question 3- What is the difference between discretionary fiscal policy and automatic fiscal policy?

Answer 3-

Discretionary Fiscal Policy: These are the government policies that improves government spending or taxes. The purpose of these policies is to expand or shrink the economy as per the requirement.

Central government can introduce a tax cut or can raise the tax rate, change personal income tax exemptions or deductions, grant tax rebates or credits etc.

Automatic fiscal policy: These are the type of fiscal policy which are used to designed to offset fluctuations in a nation’s economic activity automatically without the government or policymakers. These policies are the impact of cyclical expansions and contractions.

These changes occur without any deliberate legislative actions. For example during the time of recession, people lose their jobs and earned incomes are reduced changes in the government expenditures and taxes occurs due to that. These unemployed people will be now eligible for unemployment benefit. Further these unemployed people will experience a decline in the percentage of their income which is taxed, due to which there will be lower tax payments or tax refunds.

Question 4- What is the government expenditure multiplier?

Answer 4- Government expenditure multiplier is defined as the impact of a change in income following a change in government spending. The symbol is kG. It is the ratio of change in income (∆Y) to a change in government spending (∆G).

Question 6- What are some of the limitations of fiscal policy? Briefly discuss them.

Answer 6- Time Lags: This occurs when a need is recognized and the impact of the fiscal policy is felt. First, the government has to intervene. Then it has to come in terms of the appropriate legislation. Later on according to the situation and by analysing it. This process takes a lot of time.

Impact on private economy: When the government borrows the money in order to fund the fiscal policies, it directly competes with the business sector and with the consumers who wish to borrow money. This will result into crowding out which can result in a rise in interest rates due to which the borrowers have to move out of the market.

Size of the fiscal measures: When the budget consists of small part of the national income in the developing economies , the fiscal policy will not have desired impact on the development of the economy.