Cambridge International as and a level Economics Ebook

Types of policy
Fiscal policy
Fiscal policy
is the use of taxation and government 
spending to manage aggregate demand in order to achieve 
the government’s macroeconomic aims.
Refl ationary or expansionary fi scal policy is designed 
to increase aggregate demand. Th
is can be achieved by 
a government increasing its spending and/or cutting 
tax rates or the tax base. In contrast, defl ationary or 
contractionary fi scal policy is intended to lower aggregate 
demand. Th
is time, the government will reduce its 
spending and/or increase taxes.
Changes in government spending may be the result 
of changes in government policy or the result of changes 
in economic activity. Deliberate changes in government 
spending and taxation can be referred to as 
discretionary 
fi scal policy
.
A government can also allow 
automatic stabilisers
to 
infl uence aggregate demand. Automatic stabilisers are forms 
of government spending and taxation that change, without 
any deliberate government action, to off set fl uctuations in 
GDP. For example, during a recession, government spending 
on unemployment benefi ts automatically rises because there 
are more unemployed people. Tax revenue from corporation 
tax, income tax and indirect taxes will fall automatically as 
profi ts, incomes and expenditure decline. 
how tax revenue and government expenditure change 
automatically as GDP changes.
Budget: 
an annual statement in which the government 
outlines plans for its spending and tax revenue.
KEY TERM
115
Chapter 5: Government macro intervention 

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government’s spending and taxation plans for the year ahead. 
A budget surplus arises when tax revenue exceeds government 
spending. In contrast, a budget defi cit occurs when 
government spending exceeds tax revenue and a balanced 
budget is when government spending matches tax revenue.
Most governments seek to achieve a balanced budget 
over time. In the short term, a government may aim for, or 
welcome, a budget defi cit if there is a low level of economic 
activity. A budget defi cit that occurs due to automatic 
stabilisers is known as a