ECONOMIC POLICY

Q77. Why does fiscal policy matter?

The word 'fiscal' comes from the Latin fisca, meaning purse. Fiscal policy is the use of government funds to change behaviour within the economy.

In 1829, the philosopher and economist John Stuart Mill made the key intellectual leap in understanding how to fight what he called 'general gluts'. Mill determined that excess demand for some particular set of assets in financial markets was mirrored by excess supply of goods and services in product markets, which in turn generated excess supply of workers in labour markets. Mill found that, if one relieved the excess demand for financial assets, one also might cure the excess supply of goods and services (the shortfall of aggregate demand), and the excess supply of labour (mass unemployment). Therefore, there is a role for fiscal policy in stabilising an unstable economy.

For example, say there is an unemployment problem. The government can increase its expenditure this year, and give the unemployed jobs. These new workers will spend their wages on food, clothes, and other wants and desires, and so buoy up the economy. However, the extra government expenditure must be paid for, either by increasing taxes, borrowing, or eating into the country's savings, over time. The fiscal policy mix (sometimes called the fiscal stance) is very important.

The most important component of fiscal policy is the government's budget, which determines how much it will spend on goods and services in a given year. The amount of the budget is usually tied to tax revenues, government borrowing from other countries and other sources of income like printing money, for the government.

In a nation with a neutral fiscal policy, the budget attempts to balance tax receipts and expenditures exactly. Expansionary budgetary policies may create a budget deficit, because the government is spending more than it takes in, at least in the short-term. Contractionary budgetary policies can create a surplus, as tax revenues exceed budget expenditures.

Q78. What is money and why is it useful?

Money is any asset acceptable as a unit of exchange. Paper, gold, rocks, seashells, cigarettes - all can be used as money, as long as one party is willing to exchange their goods for your goods using the money as the unit of exchange. So your goods are valued in terms of the money-units, and so are mine.

The existence of money causes several societal changes. People need not barter any more, avoiding a double coincidence of wants, meaning that I must need what you have and you must need what I have, otherwise neither of us gets what we want. Instead, we each can exchange our goods for money and then spend the money on whatever we want.

The existence of money also causes specialisation in production, reduces the complexity of exchange, and functions as a store of value as well: €10 buys more of the same stuff than €5, all other things being equal.

Money is used as a standard of deferred payment also: I'll give you €10 tomorrow for work done today, and so it allows contracting to take place.

Finally, money is used as a unit of account: we can have €100, €1,000, or €1 million in our bank accounts, and understand what our purchasing power is, in terms of these units.

Money is subject, however, to inflation, deflation, hyperinflation, and disinflation. So be warned: it's not all good.

Q79. What is the money supply?

The money supply is the amount of currency in circulation or in use on any given day in an economy. The money supply is important because, if there is too little money in an economy, prices will rise, and economic activity will grind to a halt. If there is too much money supplied to an economy, the value of the money itself collapses, and there may be an inflationary episode, or perhaps a hyperinflation in extreme cases.

There are many measures of the money supply. Some economists look only at the money being used as cash in the system, such as notes and coins. Other definitions include the amount on deposit in banks plus the amount in circulation, plus cash on deposit at private banks, plus cash on deposit at building societies, plus amounts invested in bonds, and so on.

These various measures make up the money supply at any given time. Monetary policy acts on these different measures in different ways, ensuring the practice of monetary policy is an art, rather than a science.

 
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