Role Of Fiscal Policy In Economic Growth – 1- The role of fiscal policy in economic development Traditionally, fiscal policy is assigned three roles: Reallocating resources in the economy with the provision of public goods in the hope of correcting market failures. Redistribution of income and wealth with the system of taxes and benefits, as well as with public education and other services. Macroeconomic stabilization in the short and long term. A counter-cyclical fiscal policy, if properly implemented, can help smooth short-term business cycle fluctuations. Fiscal policy can contribute to stable, long-term output growth with low inflation by maintaining sound fiscal positions and limiting the growth of public debt.
2- Budget balance The fiscal consolidation of the early 1980s restored the budget balance on a sustainable path. The recent economic crisis had a severe but short-lived impact on the balance sheet. Budget Surplus/Deficit Korea OECD Note: Consolidated Central Government Note: General Administration. Source: Ministry of Finance and Economy Source: OECD.
- 1 Role Of Fiscal Policy In Economic Growth
- 2 Welcome To Econland Your Role: You Are Responsible
- 3 Fiscal Policy Roadmap Seminar
- 4 Case For Expansionary Fiscal Policy
- 5 All About Fiscal Policy: What It Is, Why It Matters, And Examples
Role Of Fiscal Policy In Economic Growth
4 -3- Expenditure growth Fiscal consolidation in the 1980s took the form of expenditure containment rather than revenue growth. Real Expenditure and Income Growth Note: Real values were obtained by deflating nominal values with the GDP deflator. Source: Ministry of Finance and Economy.
Sharing The Gains Of Automation: The Role Of Fiscal Policy
6- Government Debts The debt-to-GDP ratio has fallen steadily since the early 1980s, but rose rapidly after the crisis. When government guarantees are included, the share was 33% at the end of 2003. Government debt Korea OECD Note: Central government. Source: Ministry of Finance and Economy Note: General Government, at the end of 2003. Source: OECD.
7- Government Debts In the early days of government-led economic growth, external borrowing played a crucial role in providing funds for public and private investment. Debt / GDP ratio Source: , Korea Development Institute; , Ministry of Planning and Budget.
7 -8- Expenditure Size Net spending and borrowing as a % of GDP declined during the 1980s and then increased in the 1990s. It peaked in 1998 as a result of expansionary fiscal policy during the crisis. Expenditure and net borrowing and income Source: Ministry of Finance and Economy.
8 -9- Expenditure size Total government expenditure corresponds to 23.0% of GDP, much lower than in other countries. But the difference is largely due to lower social benefits in Korea. General public expenditure Source: OECD
Market Discipline First Requires Policy Discipline
10- Fiscal and social security burden The increase in expenses was accompanied by an increase in fiscal and social security burdens. Tax burden and social security burden Korea OECD
11- Sectoral allocation of expenses Economic affairs occupied the largest part of total expenses. Social protection spending is rising after the recent crisis. Trends in net spending and borrowing (% of total spending and net borrowing) 1970 1980 1990 2000 2003 General public services Defense Public order and safety Education Health Social protection Housing and community facilities Recreation, culture and religion Economic affairs Other spending 23.7 – 1 12. 1.3 4.9 0.3 1.4 27.4 2.2 4.0 30.6 4.6 14.6 1.0 5.7 2.5 0.7 26.0 10.4 4.2 20.0 4.3 17.0 1.7 8.1 4.9 0.7 26.0 10.4 4.2 20.0 4.3 17.0 1.7 8.1 4.9 0.7 4 4.6 15.3 0.7 5.3 0 .8 25.2 16.2 6.7 11.4 5.3 15.0 0.4 13.5 5.0 0.8 28.7 12.8 Sources: Ministry of Finance and Economy.
12- Expenditures for economic affairs Expenditures for economic affairs correspond to 6% of GDP, much higher than those in advanced countries. Economic Affairs Expenditure Note: Central government for Korea and general administration for others. Source: IMF. 1 2 3 4 5 6 7 USA Germany France UK Canada Korea (% of GDP) Other economic business Transport and communications Mining, manufacturing and construction Agriculture and fishing Fuel and energy
13 Government Borrowing Expenditures for economic business often take the form of borrowing. Government Borrowing Stock of Outstanding Loans Note: Net Borrowings = New Borrowings – Repayments. Sources: Ministry of Finance and Economy.
Welcome To Econland Your Role: You Are Responsible
14- Coping with the 1997 crisis During , the government granted loans to the Korea Deposit Insurance Corporation (KDIC) and the Korea Asset Management Corporation (KAMCO) in the amount of interest payments on the restructuring bonds issued by these corporations. The government also provided guarantees for these bonds. In 2002, the government announced a plan to take over part of the bonds (49 trillion won) and convert them into treasury bonds. The rest will be reimbursed by KDIC and KAMCO. In 2003, 13 trillion won was spent on transformation. The figure for is 12 trillion won every year. In addition, the government significantly expanded welfare programs to help the poor and unemployed.
14 -15- Evaluation Overall, Korea’s fiscal policy has successfully fulfilled its roles: Resource allocation: Emphasis has been placed on promoting economic growth with heavy spending on education, infrastructure and other public goods. Income distribution: After the crisis, spending on social protection is growing rapidly and is expected to increase further in the coming years. Stabilization: prudent management of fiscal policy has contributed to a sound fiscal position and a low debt-to-GDP ratio. But short-term stabilization has been limited due to the small size of tax revenues and social spending.
15 -16- Evaluation The Korean economy recorded an average growth rate of about 8%. Inflation was sharply reduced in the early 1980s and fell further after the crisis of 1997. Output growth and inflation Source: Bank of Korea.
16 -17- Evaluation Korea is also known as a country with a relatively fair distribution of income, even though inequality has increased significantly since the crisis. Gini coefficient Source: Hyun (2003) and Yoo (2004).
How Does The Economy Work?
18- Challenges Government spending has been on an upward trend since the mid-1990s, and the proportion of “mandatory spending” is increasing, requiring a conscious effort to restrain spending growth. Increase in spending Source: Ministry of Finance and Economy.
18 -19- Challenges Expanded government lending activity appears to play a substitutive, rather than complementary, role for commercial banks. Direct support to private agents, including government loans, should be reduced to enhance complementarity. Loans through Financial Assets Commercial Banks/GDP
20- Challenges On the other hand, the government should increase its efforts in providing basic public services, such as public security, judicial services, promoting competitive business practices, statistical services, etc. Employment of the Public Sector
Fiscal Policy Roadmap Seminar
During a recession, the government may lower tax rates or increase spending to encourage demand and stimulate economic activity. Instead, to combat inflation, it can raise rates or cut spending to cool the economy.
Fiscal policy is often contrasted with monetary policy, which is enacted by central bankers rather than elected government officials.
US fiscal policy is largely based on the ideas of British economist John Maynard Keynes (1883-1946). He argued that economic recessions are due to a deficiency in the consumption expenditure and business investment components of aggregate demand.
Keynes believed that governments could stabilize the business cycle and regulate economic output by adjusting spending and fiscal policies to compensate for deficiencies in the private sector.
Case For Expansionary Fiscal Policy
His theories were developed in response to the Great Depression, which challenged the assumptions of classical economics that economic changes were self-correcting. Keynes’s ideas were very influential and led to the New Deal in the US, which involved massive spending on public works projects and welfare programs.
In Keynesian economics, aggregate demand or spending is what determines the performance and growth of the economy. Aggregate demand consists of consumer spending, business investment spending, net government spending, and net exports.
According to Keynesian economists, the private sector components of aggregate demand are too variable and too dependent on psychological and emotional factors to sustain sustained economic growth.
Pessimism, fear and uncertainty among consumers and businesses can lead to economic recessions and depressions. In addition, excessive public sector exuberance in good times can lead to an overheated economy and inflation.
All About Fiscal Policy: What It Is, Why It Matters, And Examples
However, Keynesians believe that taxation and government spending can be rationally managed and used to counteract excesses and shortfalls in private sector consumption and investment spending in order to stabilize the economy.
When private sector spending falls, the government can spend more and/or tax less to directly increase aggregate demand. When the private sector is overly optimistic and spends too much, too quickly on consumption and new investment projects, the government can spend less and/or tax more to reduce aggregate demand.
This means that to help stabilize the economy, the government should run large budget deficits during economic downturns and run budget surpluses when the economy is growing. These are known as expansionary or contractionary fiscal policies, respectively.
During the Great Depression of the 1930s, unemployment in the US rose to 25% and millions stood in lines for food. The misery seemed endless. President Franklin D. Roosevelt decided to implement an expansionary fiscal policy. It launched
Expansionary Fiscal Policy: Risks And Examples
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