MacroeconomicsI_working_version (1)

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Chapter 12
The main tools of government’s fiscal policy are the budgets to control and record their
fiscal affairs. The budgets include the expected revenues from tax systems on one side and
the planned expenditures of government programs (education, health care, defence,
welfare, etc.) on the other one.
There are three situations describing the results of state finance. The government has a
balanced budget when revenues and expenditures are equal during a given period. A
budget surplus occurs when all taxes and other revenues exceed government
expenditures. The most often situation is a budget deficit, which occurs when
expenditures exceed taxes.
To pay a budget deficit, government must borrow money from the public to pay its bills.
The public purchase bonds issued by government that confirm to return money at some
specified time in the future. The total value of government bonds owned by the public
(households, banks, firms, foreigners, and other entities) referring to total or accumulated
borrowings by the government is called the government debt.
12.1. Discretionary Fiscal Policy
Discretionary fiscal policy refers to the intentional or deliberate manipulation of
government spending or taxes by government to influence GDP, stimulate economic
growth, support employment and control inflation. “Discretionary” means that the changes
in taxes and government spending do not occur automatically, independent of specific
government action. Such measures are at the options of government.
12.1.1. Expansionary Fiscal Policy
Expansionary fiscal policy becomes useful when the business cycle is in its contraction
phase. Let’ s suppose a large decline in investment spending has shifted the economy’s
aggregate demand curve leftward from AD to AD’ in Figure 12.1. The figure describes an
economy experiencing decline in output (recession) and cyclical (involuntary)
unemployment.
Government may use some form of fiscal policy to improve and stabilise the economy.
Generally, there are three main alternatives of taking some fiscal actions: increase in
government expenditures (1), cuts in taxes (2), combination of the previous two (3). A rise
in government spending implies a government budget deficit (government spending
exceeding tax revenues) in case that the deficit was in balance before that fiscal option.
This rise in government expenditures (ceteris paribus) will move an economy’s
aggregate curve to the right, as from AD’ to AD in Figure 12.1. The reduced taxes will
bring the same effect, which is moving the aggregate demand curve rightward from AD’
to AD.