This below its potential. For this reason, it

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This article is about using fiscal policy to buttress
overall economic growth through increased government spending. The focus of the
article is on South Korea, where economic growth has been slow in the past 2
years due to its aging population.


Fiscal policy is the manipulations by the government
of its own expenditures and taxes in order to influence the level of aggregate
demand. For this reason, it is a demand-side policy and a way of stimulating
economic growth. Economic growth is the increases in total real output produced
by an economy, measured as a percentage increase in GDP over a select time
period. It is one of the four main macroeconomic goals and is necessary to
sustain a population.


According to the Keynesian economic model, during a
deflationary gap an increase in aggregate demand will not result in an increase
will not result in an increase in inflation. The diagram below displays the
effect of increasing aggregate demand through government expenditure.

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It is apparent that such increase in aggregate demand
results in increased output (GDP) and does not result in increased inflation.

This is because the economy is underperforming, below its potential. For this
reason, it appears necessary to implement demand-side policies.


The main form of fiscal policy that the South Korean
government is implementing is the increased amount of government spending.

Increased government spending will result in increased aggregate demand because
government spending is a component of aggregate demand. According to the
article, the majority of this government expenditure is being put into transfer

The main advantage of fiscal policy is its ability to
pull a country out of recession. According to Keynes, wages and prices are
inflexible when the economy is in a deflationary gap. Low aggregate demand
could thereby keep the economy stuck in a deflationary gap indefinitely. It is
evident that monetary policy does not work very well in getting an economy out
of recession, due to decreased consumer confidence. With fiscal policy however
the government directly impacts demand, without other uncertainties that could
arise through other methods of improving economic growth. Furthermore, fiscal
policy enables governments to target specific sectors of the economy, allowing
them to prioritize ones with more importance than others. For South Korea,
transfer recurrent payments would be made as subsidies to companies creating
jobs, thereby redistributing income to increase aggregate demand.


A disadvantage of fiscal policy is that they take much
time to implement. The economic situation of a country could have changed by
the time the government is able to implement a policy, therefore making it
ineffective. Further,
this could cause governments to face political pressure due to the population
becoming dissatisfied with the apparent inactiveness of the government.


A theoretical disadvantage of fiscal policy is a
concept known as crowding out. The crowding out effect is the idea that as
governments increase their government expenditure by demanding more loans, the
interest rate will increase and thus the amount of investments decreases. This
theory hypothesizes that increased government expenditure will decrease
investment. Thus making increased government expenditure ineffective. However,
there has been little evidence of this happening in the real world.


The more
pressing issue than the theoretical crowding out effect is the fact that it
increases government debt for South Korea. The article stated that government
debt as a percentage of GDP is estimated to remain at 39.6%, this is an
all-time high for South Korea. The risks of high government debt are the
potential of higher interest payments, lower national savings and thereby a
decreased ability to respond to problems.


Another main concern with fiscal policy is its
potential to cause inflation. If aggregate demand is not below aggregate
supply, there will be increased inflation. For this reason, fiscal policy is
only beneficial in the short run, while supply-side policies are beneficial in
the long run. This is vital to understand when looking at South Korea’s
situation. While economic growth has been slow, South Korea has not been in
recession. This could mean that such fiscal policy could instead increase
inflation, as represented in the diagram below.


In conclusion, fiscal policy implemented through
increased government expenditure is beneficial to economic growth, however when
implemented during inappropriate stages of the business cycle it could lead to
increased inflation. This would be even more apparent considering South Korea’s
aging population is a supply-side issue, as labour is one of the four factors
of production which South Korea is losing due to to its decrease in young

Categories: Inflation


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