Fiscal Policy - Deflationary Fiscal Policy

Deflationary fiscal policy is likely to be most appropriate in times of economic boom. If the economy is growing at above its capacity this is likely to cause inflation and balance of payments problems. To try to slow the economy down the government could either raise taxes in some form or perhaps reduce government expenditure. Either of these will reduce the level of demand in the economy and therefore the level of economic growth. It may increase indirect taxes which will raise prices and deter people from spending so much, or it may increase direct taxes, which will leave people with less money in their pockets and so stop them from spending so much.

Deflationary fiscal policies could therefore include:

• Increasing the lower, basic or higher rates of tax
• Reducing the level of personal allowances (see the income tax explanation for more details on these)
• Reducing the level of government expenditure

Why not try some of these policies on the Virtual Economy? Click on the 4th floor on the side bar or on the link at the top of the page to access the model and try these policies. Try any of them and see the effect they have on the level of economic growth, unemployment and inflation. You should find growth reducing, unemployment increasing and inflation falling (after a time-lag perhaps).