As mentioned last week, in today’s theme, I shall zoom into the fiscal sector in respect to the performance as at the half-year ended June 2017. First and foremost, let us begin this discussion by defining what fiscal policy is, and how it is used and/or should be used to influence the activities within the economy. The most basic definition of fiscal policy is the use of government spending and taxation to influence the economy. The ideal objective in this regard is that fiscal policies are normally used by governments to promote resilient and sustainable growth, and reduce poverty. Now, putting this into context, governments can only influence an economy; or rather, the objective in respect to the management of an economy can only be done from either of two dimensions; expansionary – expansionary policies to support the growth of an economy; or contractionary – to slow down the rate of growth in an economy and, by extension, the result is a contracting economy, wherein firms downsize their operations, unemployment rate goes up, and so on. Point of interest, however, is that these outcomes (expansion & contraction of an economy) can either occur or be achieved through deliberate policies that are being implemented; or unintentionally, for example, the Government may implement a policy, such as reducing income tax or, in Guyana’s context, increase the income tax threshold, thereby increasing disposable income for consumers or spenders in an economy. The goal of such a policy is to encourage and stimulate increased spending, but if, due to lack of confidence by householders/consumers and even firms – whereby they fear to spend amidst great uncertainty, then in such circumstance, they would rather save the excess than spend, and this will ultimately lead or contribute to an even more contractionary outcome, which would in effect be contrary to the objective of the policy.In the wake of the recent global financial crisis of 2008/2009, governments have had to lend support to financial systems, jump-start growth, and mitigate the impacts of the crisis on vulnerable groups.
How does fiscal policy work?In order for policy makers to influence the economy, they basically have two main tools at their disposal; fiscal policy and monetary policy. Economic activities are influenced by governments through changing the level and types of taxes, the extent and composition of spending, and the degree and form of borrowing. On the monetary aspect of the equation, economic activities are indirectly targeted by Central banks, by influencing the money supply through adjustments to interest rates, bank reserve requirements, the sale of government securities, and foreign exchange. The manner in which resources are used in the economy is also influenced by governments, both directly and indirectly. To contextualise this assertion, let us illustrate this using the basic equation for national income, which is:
GDP = C + I + G + NXWhere GDP is gross domestic product (the value of all final goods and services produced in the economy; ‘C’ represents private consumption; ‘I’ represents private investments; ‘G’ represents purchases of goods and services by the government; and exports minus imports, or net exports, is represented by ‘NX’, most economics texts express this as X-M – in other words, the right side of the equation represents aggregate spending, or demand. This equation illustrates evidently that governments affect economic activity by controlling government spending (G) directly and influencing C, I and NX indirectly through changes in taxes, transfers and spending. An expansionary policy is therefore achieved when fiscal policies are designed to increase aggregate demand directly through increase in government spending. By contrast, fiscal policy is considered contractionary or tight if aggregate demand is reduced via lower spending. Aside from providing goods and services, fiscal policy objective may vary. For example, in the short term, a government’s focus may be macroeconomic stabilisation – stimulating an ailing economy, helping reducing external vulnerabilities, and fighting rising inflation, for example. In the long term, on the other hand, the aim may be to foster sustainable growth or reduce poverty. In doing so, such focus would be centred on things like infrastructure and/or education – these could also be referred to as supply side activities. Having thus laid a theoretical underpinning of fiscal policy from a practical standpoint, next week I shall extend this discussion by contextualising today’s discussion on the actual outcomes of the fiscal performance achieved, as reported in the recent mid-year report for the fiscal year of 2017.
