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FISCAL POLICY Types of Fiscal Policy PART 6 BY AYUSSH SANGHI
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Expansionary Fiscal Policy It is defined as an: k increase in government expenditures and/or a decrease in taxes that causes the government's budget deficit to increase or its budget surplus to decrease.
Expansionary Fiscal Policy In case of Expansionary fiscal policy, government needs to borrow from: domestic or foreign sources, k draw upon its foreign exchange reserves or print an equivalent amount of money
Impact Excessive printing of money leads to inflation If the government borrows too much from abroad it leads to a debt crisis. If it draws down on its foreign exchange reserves, a balance of payments crisis may arise. Excessive domestic borrowing by the government may lead to higher real interest rates and the domestic private sector being unable to access funds resulting in the crowding out of private investment s a combination of these can occur. In any case, the impact of a large deficit on long run growth and economic well-being is negative. Therefore, it is not prudent for a government to run an unduly large deficit.
Contractionary Fiscal Policy This type of fiscal policy is defined as a: k decrease in government expenditures and/or * an increase in taxes * that causes the government's budget deficit to decrease or its budget surplus to increase.
What kind of countries would adopt so? * In case of developing countries, where the need for In case of developing countries, where the need for infrastructure and social investments may be substantial running surpluses at the cost of long-term growth might also not be wise. * The challenge then for most developing country governments is to meet infrastructure and social needs while managing the government's finances in a way that the deficit or the accumulating debt burden is not too great.
Classical View of Fiscal Policy The classical view of expansionary or contractionary fiscal policies is that such policies are not necessary as there are market mechanisms. Example: The flexible adjustment of prices and wages -which serve to keep the economy at or near the natural level of real GDP at all times. Accordingly, classical economists believe that the government should run a balanced budget every year.
Keynesian View of Fiscal Policy The belief that expansionary and contractionary fiscal policies can be used to influence macroeconomic performance is most closely associated with Keynes and his followers. * Keynesian theories of output and employment were developed in the middle of the Great Depression of the 1930s, when unemployment rates in the U.S. and Europe exceeded 25% and the growth rate of real GDP declined steadily for most of the decade. x Keynes and his followers believed that the way to combat the prevailing recessionary climate was not to wait for prices and wages to adjust but to engage in expansionary fiscal policy instead.