What this lesson teaches
I can explain fiscal, monetary and supply-side policy and judge how well each works.
Syllabus 9570, 3.2.3(b). Macroeconomic Policies: Policy measures and their effectiveness in achieving macroeconomic objectives:; Fiscal policy - How discretionary fiscal policy can influence the level of economic activities and living standards through government spending and taxation; Monetary policy - How monetary policy can influence the level of economic activities and living standards through the management of exchange rates (case of Singapore) and interest rates; Supply-side policies - How supply-side policies can improve quantity, quality and mobility of factors of production to increase the productive capacity of an economy and hence affect living standards
Make a guess
The government cuts income tax by $1 billion in a downturn. Does AD rise by $1 billion straight away?
- Yes. A $1 billion tax cut adds $1 billion of spending.
- No. Households save some of it and spend some on imports.
- No. A tax cut raises firms' output, so it shifts AS rather than AD.
Show the answer
No. Households save some of it and spend some on imports.
Only the part spent on local output raises AD in the first round. Saving and imports leak out.
Raising government spending or cutting taxes increases AD; the reverse reduces it.
Fiscal policy is the use of government spending and taxation to influence the economy.
Expansionary fiscal policy raises G or cuts taxes. Higher G directly raises AD. Lower taxes raise disposable income, so consumption rises. Through the multiplier, national income rises by more than the first injection.
Contractionary fiscal policy cuts G or raises taxes, reducing AD to ease inflation.
Singapore used large expansionary budgets during COVID-19, including the Jobs Support Scheme, which helped firms keep paying workers.
- Expansionary
- Raise G or cut taxes: AD right.
- Contractionary
- Cut G or raise taxes: AD left.
Worked example: Repairs and a tax cut
In a downturn, the government brings forward building repairs and cuts personal income tax.
- Repairs: G rises directly, and construction workers are hired.
- Tax cut: households have more disposable income, so C rises.
- Both shift AD right, and the multiplier spreads the effect.
- Some of the tax cut may be saved, so its effect is smaller than the repairs.
Watch out for this
A tax cut raises AD by the full amount of the cut.
Households save some of it and spend some on imports, so AD rises by less than the tax cut.
Check your understanding
The government raises spending on public hospitals. What is the direct effect?
- C falls, because taxes must rise.
- G rises, so AD shifts right.
- AS shifts right immediately.
Show the answer
G rises, so AD shifts right.
Right. Government spending on goods and services is part of AD.