Effectiveness of fiscal policy
What is the effectiveness of fiscal policy
The effectiveness of fiscal policy refers to the degree to which the implementation of fiscal policy guides economic growth, price levels, employment levels, and changes in international payments close to the predetermined policy goals. If the implementation of the fiscal policy can make the changes in the above four indicators reach the predetermined policy goals, it indicates that the fiscal policy is effective; otherwise, it is ineffective. If the deviation between the changes in the above four major indicators and the predetermined policy objectives is small, it indicates that the fiscal policy is relatively effective; if the deviation is large, the effectiveness of the fiscal policy is low.
The effectiveness of fiscal policy in a closed economy
(1) Factors that determine the effectiveness of fiscal policy
In a closed economy, the main tools for the government to regulate the economy are fiscal policy and monetary policy. The relative effectiveness of fiscal policy and monetary policy depends on the following two conditions: one is the sensitivity of investment demand to interest rates, and the other is the sensitivity of money demand to interest rates. These two conditions can be explained by the slope of the Is-LM curve. If investment demand is sensitive to interest rates, the Is curve will be relatively flat, because small changes in interest rates will cause larger changes in investment demand; on the contrary, if investment demand is not sensitive to interest rates, the Is curve will be relatively steep. Similarly, if money demand is sensitive to interest rates, the LM curve will be relatively flat, and small changes in interest rates will cause large changes in money demand; on the contrary, if money demand is not sensitive to interest rates, the LM curve will be steeper.
(2) Graphical explanation of the effective fiscal policy
If the Is curve is relatively steep and the LM curve is relatively flat, the fiscal policy is more effective.
The effect of fiscal policy is strong because even though expansionary fiscal policies may raise interest rates, investment demand is not sensitive to interest rates and has little impact on investment. The weaker effect of expansionary monetary policy is that most of the increase in the money supply is held by individuals, so the interest rate level only slightly drops, and the curve LM only slightly shifts downward.
If the IS curve is relatively flat and the LM curve is relatively steep, monetary policy is more effective than fiscal policy. The reason is: taking the expansionary monetary policy as an example, the expansionary monetary policy causes the interest rate to fall. Since the Is curve is flat, investment is sensitive to interest rates. As long as the interest rate falls slightly, it will cause a large increase in investment, which will greatly increase national income. The expansion of fiscal policy will increase interest rates, and the increase in interest rates will cause investment to fall sharply, resulting in a crowding-out effect, so the increase in national income is relatively small. (Kazuyoshi Miwa / Osamu Maruyama) (三和一善)