Unit 4 Fiscal Rules, Fiscal’s Microeconomic effects and Limitations

The UK fiscal rules would include the Golden Rule and The Sustainable Investment Rule. The Golden Rule is that new money that needs to be borrowed would have to be for new social capital for schools, hosptals etc. However in order for other spending such as transfer payments the old debt would have to be cleared first. While the Sustainable Investment rule is that the debt cannot exceed 40% of its GDP. This is one of the reasons why Monetary policy is favored but sometimes the government need to help to reduce the budget deficit so would have stealth taxes in order to raise revenue. These are taxes that are designed to go unnoticed. 

What can the Fiscal Policy do to affect the SUPPLY SIDE?

  • Incentives to work- lower income tax may encourage the people to work more as they have a higher opportunity to work more. Government may reduce welfare benefits in order to reduce the poverty trap.
  • The pattern of demand: This is where increasing taxes ad government subsidies can be used to influence the pattern of demand for goods and services. So this could mean markets for merit goods would have higher demand
  • Business Investment may be encouraged if there was lower taxes like corparation tax which would also encourage entrepreneurship. On the large scale this would help to increase output. 

Limitations of Fiscal Policy:

Even though Fiscal Policy is a policy that is able to affect both supply and demand side in a good way, one of the main reasons why monetary is used over fiscal is it is more precise in terms of what it is going to do. For example it is hard to fine tune. Also fiscal policy is to do with the government more, so it might take longer plus a time lag and government plans make take years to initiate.  The time lags tend to be longer compared to monetary policy if we use the education and training point, meaning it is impossible for it to be a fine tuning tool. Multiplier effects may take several years. 

Also increasing fiscal policy could potentially lead to crowding out which are disincentive effects for private sector. 

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