The Impact of Fiscal Policy on Macroeconomic Objectives (Edexcel IGCSE Economics)

Revision Note

Written by: Steve Vorster

Reviewed by: Jenna Quinn

Fiscal policy is used to help the government achieve their macroeconomic objectives
Specifically, the use of fiscal policy aims to achieve:
- Economic growth
- A low and stable rate of inflation
- Maintain low unemployment
- Redistribute income
- Current account stability
- Environmental protection

When a policy decision is made, it creates a ripple effect through the economy, impacting the macroeconomic objectives of the government
- Expansionary fiscal policy is used to stimulate growth and create employment
  - This can lead to higher tax revenues, which can be used to redistribute income
- Contractionary fiscal policy is used to tackle inflationary pressures
  - This may have the side effect of reducing growth and increasing unemployment

Expansionary fiscal policies involves decreasing taxes and/or increasing government spending
- The aim is to grow the economy

Explaining the Impact of Expansionary Fiscal Policy

Example 1: The Government decreases corporation tax
Effect on the economy	The net profit of firms increases → investment by firms increases → output of the economy expands → more workers are required income per capita increases
Impact on macroeconomic aims	Economic growth increases Inflation rises due to increased short-term investment spending Unemployment may decrease as output rises, which requires more workers Current account: exports may increase due to new investments leading to better quality output, but imports may also rise due to higher income households buying imports There may be more damage to the environment as industrial output increases

Example 1: The Government decreases corporation tax

Effect on the economy

The net profit of firms increases → investment by firms increases → output of the economy expands → more workers are required income per capita increases

Impact on macroeconomic aims

Economic growth increases
Inflation rises due to increased short-term investment spending
Unemployment may decrease as output rises, which requires more workers
Current account: exports may increase due to new investments leading to better quality output, but imports may also rise due to higher income households buying imports
There may be more damage to the environment as industrial output increases

Example 2: The Government increases spending on infrastructure
Effect on the economy	More building firms employ workers → household income increases → consumption increases
Impact on macroeconomic aims	Economic growth increases Inflation pressures rise Unemployment may decrease as construction employers hire more workers The current account deficit may worsen as households spend more on imports

Contractionary fiscal policies involves raising taxes or decreasing government spending

Examples of the Impact of Contractionary Fiscal Policy

Example 1: The Government increases the rate of income tax
Effect on the economy	Households pay more tax → discretionary income reduces → consumption reduces → the pace of economic growth slows down
Impact on macroeconomic aims	Economic growth slows down Inflation eases Unemployment may increase as output is falling and fewer workers are required A current account surplus may occur if households purchase less from abroad (imports) Environmental protection improves as economic growth slows down

Example 2: The Government freezes or reduces the pay of public sector workers
Effect on the economy	Public sector wages stagnate or reduce → consumer confidence falls → consumption decreases
Impact on macroeconomic aims	Economic growth slows down Inflation eases Unemployment may increase as output falls The current account may improve as households spend less on imports

Example 3: The Government cuts spending in the budget
Effect on the economy	There is less government demand for goods and services → less income for firms → output and profits decrease
Impact on macroeconomic aims	Economic growth slows down Inflation eases Unemployment may increase as output falls Less corporation tax is available for redistribution A current account surplus may occur if imports are reduced Environmental damage may fall as the level of output in the economy falls

Last updated: 21 June 2024

the (exam) results speak for themselves:

Did this page help you?