Perhaps the most important demand management policy is fiscal policy. The government’s fiscal policy is the level of government expenditure and tax rates used to control aggregate demand in the UK. Currently, the UK has a large rate of unemployment and was reported to be at 8.4% in January of 2012 (TradingEconomics). Government spending is a strong solution to the problem of unemployment, making fiscal policy an appropriate policy to promote economic growth. For example government spending on various projects such as the London 2012 Olympics provides many employment opportunities.
However government spending has recently decreased and job cuts are being made in the public sector in order to reduce the deficit. The current economic climate in the UK is making economic growth difficult, especially in employment levels. This is a major problem, because with less people in the UK employed, consumers have less disposable income and so there is less aggregate demand to increase economic growth.
Unfortunately the government is now in a ‘catch 22’ situation where the job cuts that are required to reduce the UK’s debts are undermining policies that promote economic growth. These other fiscal policies include lowering tax rates to motivate the UK public to spend more than save. For example, lower VAT and income tax in the UK will increase demand, as consumers possess more disposable income causing an increase in sales and eventually economic growth. This is another example of how fiscal policy is appropriate in promoting economic growth in the UK, however the necessary cuts to the public sector make the policies less effective.
Although having a good potential to increase aggregate demand and promote economic growth, fiscal policy also has its weaknesses, as it is not definite that a policy will increase aggregate demand. Fiscal policies rely on the other aspects of aggregate demand, and when implementing fiscal policies, several of these other factors must be considered to determine the policy’s success. For example if consumer buying confidence is low, reducing tax rates will not guarantee an increase in consumer expenditure. Therefore to be appropriate in promoting economic growth in the UK, fiscal policies must consider other factors in the current economic situation before being implemented.
Even though fiscal policy is appropriate in promoting economic growth, an issue with solely using fiscal policy to promote economic growth is ‘crowding out’. Crowding out occurs when an increase in government expenditure causes the private sector to decrease in size. This is because government spending is funded by taxes, and an increase in government spending would cause an increase in taxes (including corporation tax). This can greatly affect the private sector businesses in the UK.
As a result of intense fiscal policy, economic growth can be hindered. So in this case, fiscal policy would not be considered appropriate in promoting economic growth in the UK. This is because a tax increase to fund government spending would negatively affect privately owned businesses. Because many private companies are funded by foreign investors, this would also affect foreign investment in the UK, as an increase in tax would increase the costs of operating in the UK. If the costs became too much, foreign investors would look elsewhere to invest. Without foreign investment, private...