Thursday, April 01, 2010

On Fiscal Policy (1)

I am teaching elementary economics at school, and I touch on fiscal policy - government budget, spending, cut tax, how built-in stabilizer works, tax collection, bond issue and fiscal reform of the Japanese government.

When I think of the fiscal problems that the Hatoyama administration should solve, this report may greatly help though it is on the fiscal policy of the US.

Fiscal policy has three functions: (1) allocation of resources, (2) income redistribution, and (3) economic stabilization.

This report is almost entirely on the function of fiscal stimulus, or comment on textbook Keynesian view on fiscal policy and here's the summary of this report:

(1) On the effects of government spending

There are two effects of government spending on aggregate demand(=consumption + investment). These are positive and negative effects:

The positive effect is multiplier effect, where government purchase leads to higher income and thus today's demand.

On the other hand, the negative effects are growth-retarding effect, where government spending leads to higher taxes in the future and thus less demand today to prepare for the higher tax, and crowding-out effect, where government spending results in higher interest rate and thus less today's demand.

(2) On the effects of tax cut and spending on demand

Generally, I say that government spending is more effective on demand than is tax cut. However, some researches say that it isn't, rather it is the opposite: tax cut is more effective on demand than government spending.

Moreover, (interestingly) successful, growth-promoting fiscal stimulus is tax cut whereas unsuccessful stimulus is spending more and transfer payments, which are now (unfortunately) the Hatoyama administration's main dishes!