What this lesson teaches
I can define fiscal policy.
Syllabus K343, 4.2.4. Definition of fiscal policy
I can describe fiscal policy measures: changes in taxes and government spending.
Syllabus K343, 4.2.5. Fiscal policy measures: changes in: taxes, government spending
Make a guess
The government cuts income tax. Is this monetary policy or fiscal policy?
- Neither, because tax cuts are not a policy.
- Fiscal policy, because it changes taxes.
- Monetary policy, because it changes how much money people have.
Show the answer
Fiscal policy, because it changes taxes.
Fiscal policy uses taxes and government spending. Monetary policy, run by the central bank, uses interest rates or the exchange rate.
Fiscal policy is the use of changes in taxes and government spending to influence the economy and meet the macroeconomic aims.
Fiscal policy is the use of changes in taxes and government spending to steer the economy. The government uses it to reach its aims: growth, low unemployment, stable prices and a healthy balance of payments. In Singapore, the Minister for Finance announces the changes each year in the Budget.
Taxes. The government can change direct taxes, such as income tax and corporate tax, and indirect taxes, such as GST. A cut in income tax leaves households with more disposable income, so they spend more. A cut in corporate tax leaves firms with more profit after tax. They then have more money, and more reason, to invest in new machines and buildings.
Government spending. The government buys goods and services and pays for projects such as schools, hospitals, MRT lines and defence. It also makes transfer payments, such as cash support for low-income households. More spending adds directly to total demand, and the firms that win government contracts hire workers to carry them out.
Expansionary fiscal policy means lower taxes or higher spending. It is used when demand is weak and unemployment is rising, and it usually widens the budget deficit. Contractionary fiscal policy means higher taxes or lower spending. It is used when spending is too strong and prices are rising fast, and it usually narrows the deficit.
- Fiscal policy
- Changes in taxes and government spending.
- Expansionary
- Lower taxes / higher spending; for recession and unemployment.
- Contractionary
- Higher taxes / lower spending; for inflation.
Worked example: Singapore's fiscal response to COVID-19 in 2020
In 2020, safety measures during the COVID-19 pandemic closed many businesses for weeks, and tourists stopped coming.
- Problem: firms' sales collapsed, so many were about to lay off workers. Unemployment would rise and households would cut spending.
- Measure: the government raised its spending sharply. Its Jobs Support Scheme paid part of the wages of local workers for many months.
- Chain: firms' wage costs fell, so they had less reason to lay workers off. Workers kept their incomes and kept spending, which supported sales at other firms.
- Who paid: the government ran a large budget deficit and, with the President's approval, drew on Singapore's past reserves.
Watch out for this
Fiscal policy is when the central bank changes interest rates.
Changing interest rates is monetary policy, run by the central bank. Fiscal policy is the government changing taxes and its own spending.
Check your understanding
A government wants to reduce high inflation caused by too much spending. Which fiscal policy fits?
- Lower interest rates
- Cut taxes and raise government spending
- Raise taxes and cut government spending
Show the answer
Raise taxes and cut government spending
Right. Contractionary policy reduces total demand.
Check your understanding
Which of these is contractionary fiscal policy?
- Letting the currency fall in value
- Raising the rate of GST
- Cutting interest rates
- Spending more on new roads
Show the answer
Raising the rate of GST
Right. A higher tax takes spending power from households, which reduces total demand.