Balanced Budget Fiscal Expansion (A2 Macroeconomics)

Balanced budget fiscal expansion is defined as: a policy to increase GDP through changing government spending and taxation levels, whilst leaving the overall fiscal budget position the same.

This method of fiscal expansion could be used in two ways. The first is that if you increase spending and taxes equally, through the multiplier effect, the expansionary government spending should have a bigger positive impact on economic growth than the negative impact of higher taxes. An example of this would be to temporarily increase income tax in order to finance capital investment.

The second is through a reallocation of government funding. In this case, cuts in spending on items such as public sector wages could be used to finance higher spending on items such a as infrastructure. Again, the multiplier effect should result in the benefits of increased spending on infrastructure being greater than the costs of cutting public sector wages. Another example of this would be to reduce spending on pensions and increase spending on capital investment.

Spending on pensions may be reduced by increasing the retirement age. As well as allowing more money to be spent on funding capital investment such as infrastructure projects, people will also be working longer causing the labour force to increase. This will therefore stimulate an increase in both aggregate demand and the economy's productive potential without increasing the government's budget deficit. 

The idea of a balanced budget fiscal expansion relies on the positive multiplier effect being greater than one. Generally, unless the economy is at or close to full capacity this is likely to be the case as a result of its reduction in unemployment.

For those currently studying at A2 through OCR, balanced budget fiscal expansion is mentioned in Extract 1 of the case study for The Global Economy module. The IMF recommended that the UK pursue a balanced budget fiscal expansion to increase growth. This form of fiscal expansion, if successful, would stimulate an increase in aggregate demand without compromising the government's Deficit Reduction Plan.