Fiscal Policy

This section considers the government, which is the fiscal authority of the country. It’s the responsibility of the government to care for its citizens. To answer to this obligation the fiscal authority only has two policy instruments, namely Government Expenditure (G) and taxation (T). A third type of instrument is the way deficits on the government’s budget are financed, because it could have a large influence on the country’s economy.

The government plays a role in the economy through fiscal policy. If you page back in your handbook, you will remember that we explained economic systems according to the role the government play in the economy. Can you still remember the role of the government in a totally free market economy of Adam Smith? Under such an economic system the duties of the government is to protect its subjects against foreign enemies; maintain law and order; and to provide and maintain essential public works such as roads and schools. The government supposedly does not have a real economic function in such a free market economic system. In the command economic system the government are responsible for all the production and consumption decisions in an economy.

In the modern economy, we usually get a mixed economic system. In such economic systems the government does not solely deal with protection type of activities, but also has an economic and welfare functions such as community services (such as sewerage works), social services (education and health), economic services (the South African Bureau of Standards), subsidies (on bread, for example) and the state old-age and military veteran’s pensions scheme.

To finance all these government expenditure the government levy taxes on its citizens. These taxes also have an impact on households and businesses. We can therefore see that the role of the government has expanded from protection function to that of a full economic participant.