Effects of Fiscal Policy

CFA Level 1 - Macroeconomics

Investment sources include:

·Private saving
·Government saving
·Borrowing from foreigners

.Capital markets are influenced by fiscal policy in two ways:


·Government spending and tax policy will generate either a budget surplus or a deficit, which will in turn mean that the government sector will either contribute towards financing investment or "crowd out" private investment.·Tax policy will affect the amount saved. Taxes on interest earned will decrease the incentive to save and create a wedge between the after-tax interest earned by savers and the interest rate paid by firms.

 Generational Effects of Fiscal Policy

Current fiscal policy impacts the amount of taxes that future citizens will pay. If the government runs up long-term budget deficits, then future generations will need to pay higher taxes in order to pay the interest. Similarly, future generations will pay lower taxes if the government creates budget surpluses. Economists have created systems which examine the lifetime taxes and benefits associated with generations or age groups. Those systems are referred to as generational accounting.

A government that chronically runs deficits will, at some point in time, have to address that imbalance. This fiscal imbalance will need to be addressed with higher tax revenues and/or reduced government spending.An imbalance is also created when the government benefits received by one generation exceed the taxes paid by that generation. For example, initial recipients of Social Security in the United States received far more benefits than they paid in taxes. Such imbalances are referred to as generational imbalances.Future generations will need to pay more taxes, or receive less benefits, in order to address this imbalance. Fiscal policy therefore transfers benefits according to age; it also determines how much each generation will pay the government

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