Use Of Fiscal Policies To Achieve Stable Economic Growth In The UK Economy

Examine the use of Fiscal Policies to achieve stable economic growth in the UK economy. Fiscal Policies are the government policies which change taxation and government spending to influence Aggregate Demand to achieve macro-economic objectives. The UK's annual budget is set from 1 April to the 31st of March, currently by George Osborne, the present Chancellor of Exchequer. Economic Growth means, in the SR, increase in real GDP and in the LR increase in Productive Potential. The government is able to collect tax directly and indirectly. Direct tax being tax on income and indirect tax being tax on expenditure such as VAT. Firstly, by reducing direct tax on earnings (income tax), a household's disposable income will rise. By doing so, the household will have more funds available to spend on consumer goods and services, which likely to increase consumption. As consumption is a major component of aggregate demand (60-65% of AD), it will also increase AD as a result of this (Draw diagram), thus achieving more real output hence growth through the use of a loose/expansionary fiscal policy. However, consumption is only one component of aggregate demand, and so if the other components such as investment reduce due to more risk and low confidence level, aggregate demand may not shift to the right. Also, if the confidence level is low, as if house prices are decreasing, people will face a negative wealth effect and so prefer to save their additional disposable income rather than spending. Also saving is a leakage, and so will prevent growth. Secondly, another direct tax that can be used to increase growth is corporation tax ie. less tax to be paid on companies' profit. If corporation tax is reduced, as a part of inflationary fiscal policy, firms will retain more of their profit. This means they will have more funds and incentive to invest. As investment is a component of aggregate demand, it will also increase AD. Also, aggregate supply will increase because of the increase in investment in capital stock likely to increase productivity. (Diagram showing AD and AS shift and higher growth) Examine the use of Fiscal Policies to achieve stable economic growth in the UK economy. However, if expected rate of returns are low is low they would prefer to have precautionary measures and save their money rather than investing it, as a result not causing any improvement in productive capacity and growth. Also, directors may decide to use the excess retained profit to distribute as dividend to their shareholders rather than reinvesting in the business for expansion. Furthermore, another example of fiscal policy that can be used to grow the economy is reducing VAT, an indirect tax on the production of goods and services. By reducing VAT, the cost of production of goods and services will reduce, which gives company more profit incentive to invest. As investment increases, aggregate supply and aggregate demand will both rise as investment is a component of both. Additionally, investment is an injection in the circular flow of income therefore AD is likely to rise at a faster rate due to positive multiplier effect. Also, as VAT decreases, so should prices of goods and services, which increases international competiveness, and so will increase exports. As exports is also a component of aggregate demand and an injection, it again likely to increase real output and promote growth. However, it will depend on the magnitude in the cut of VAT, as if it is very small it may not have much of an effect on the cost of production, thus not increasing a company's profit or incentive to invest. As a result, not affecting AD or AS or growth of the economy. Also, if other costs of production rise at the same time, such as the national minimum wage or interest rate, may neutralise the impact of cut in VAT hence incentive to invest more. Another tool, the government is able use is an increase its expenditure to improve growth. For example, if government increases the subsidy to firms, aggregate demand will automatically increase as government spending is a component of aggregate demand. Also, as government spending is an injection, a rise in it will increase aggregate demand at a faster rate due to the multiplier effect. More subsidy, spending on health and education etc. work as Examine the use of Fiscal Policies to achieve stable economic growth in the UK economy. supply-side policies in the LR & improve productive potential in the LR i.e. more growth. However, if government expenditure is very high, it can lead to an increase in budget deficit and public sector net borrowing (PSNB) due to an increase in Budget Deficit. This in turn will lead to an increase in public sector net debt (PSND) i.e. national debt, which is not desired as more interest repayment by the government on their debt and will not help growth. Lastly, the government can increase its spending on welfare payments, such as benefits and JSA. This will increase the average household income, which in turn will increase consumption and aggregate demand as a result. More AD likely to increase more real output hence growth. However, an increase in government benefits can lead to a disincentive to work as people become over reliant on the government, this therefore will not help economic growth. Also, huge opportunity cost needs to be considered as government has limited funds to spend and additional spending on benefits means government may have to cut spending on health and education to compensate extra spending. This may have adverse impact on the long run productive capacity of an economy hence lower the economic growth in the LR. In conclusion, although the use of loose fiscal policies can lead to side effects, it ultimately helps growth as it increases consumption and gives firms an incentive to invest. Therefore results in an increase in AD and AS hence Economic Growth.