Unit 18 tight fiscal policy

In economics and political science, fiscal policy is the use of government expenditure and revenue collection (taxation) to influence the economy.[1]

Fiscal policy can be contrasted with the other main type of macroeconomic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and spending. The two main instruments of fiscal policy are government expenditure and taxation. Changes in the level and composition of taxation and government spending can impact the following variables in the economy:

- Aggregate demand and the level of economic activity;

- The pattern of resource allocation;

- The distribution of income.

Tight fiscal policy involves increasing the rate of taxation and / or cutting government spending. It is sometimes known as deflationary fiscal policy

The purpose of tight fiscal policy is:

· Reduce inflationary pressure by reducing the growth of aggregate demand (AD) in the economy

· Improve government finances by increasing tax revenue and reducing government spending.

Fiscal policy is likely to be tightened when the economy is growing quickly and in danger of overheating (e.g. if economic growth is above the long run trend rate of growth). However, tight fiscal policy may need to be implemented if government finances are poor and there are fears over the size of government debt.