How does the Government use fiscal policy to influence the economy? Discuss the view that the Government ought to aim to balance its budget.
A: How does the Government use fiscal policy to influence the economy?
B: Discuss the view that the Government ought to aim to balance its budget.
A: The government can use fiscal policy in a number of ways to influence different aspects of the economy. By changing key policies, the government can encourage the economy to change the way it is working. If the economy is a bit sluggish and people are not spending very much so that businesses are not growing, then the government may decide to use a reflationary set of policies designed to get the economy growing. They can do this by lowering taxes or by keeping taxes at the same level and instead spending more money with businesses and producers within the economy. Alternatively, if the economy is doing particularly well and growing significantly the government may be worried that there is a risk of inflation so they may want to gently slow down how much people are spending. This would mean introducing deflationary policies, such as raising taxes or reducing public spending so that the economy would begin to grow at a slower rate and the risk of inflation would be reduced. Since the 1997 election, the governments ability to influence the economy has declined a little. Up until 1997, the government also took responsibility for setting interest rates and this gave them another tool for controlling the economy. If the economy was at risk of ‘overheating,’ so that inflation was a risk, then interest rates could be raised. Raising interest rates makes it more expensive to borrow money and also makes it more attractive for people to leave their money in the bank where it gets a high rate of interest. So varying the interest rates provided a way of influencing the economy. In 1997 the incoming labour government took the decision to make the Bank of England responsible for interest rates so the UK government can no longer directly use ‘interest rates’ as a tool for influencing the economy. Here is a diagram which shows how the use of fiscal policy through taxation can work.
