How strong an economy is depends on the national income, which is equivalent to the value of national output when it is in equilibrium, i.e. S+T+M=I+G+X. The austerity measures are represented by the reduction of G in the diagram, which will lead to a decrease in national income, unless the nation finds ways to reduce tax, encourage private investment and increase exports volume.
Government Expenditure
Government expenditure includes
When the government adopts a contractionary policy,i.e, reducing the amount of government expenditure, the AE function is expected to shift downwards. This deliberate action by the government is known as discretionary fiscal policy.
- Government spending on recurrent expenditure (eg. salaries of civil services and operating costs of running various government services such as health-care and education).
- Government spending on social capital or infrastructure (eg. building new roads, new MRT lines, news airports, new hospitals and schools).
When the government adopts a contractionary policy,i.e, reducing the amount of government expenditure, the AE function is expected to shift downwards. This deliberate action by the government is known as discretionary fiscal policy.