13.1 Fiscal Policy Flashcards
What is fiscal policy ?
Use by thr gov of gov spending and taxation to try and achieve the govs policy objectives
Fiscal policy at a macro level:
Taxation
Public spending
And the govs budgetary position
Fiscal at a micro level
Taxation and subsides used to influence consumer behaviour and income tax and welfare benefits to create labour market incentives
What is a balanced budget?
Gov spending=gov revenue
What is budget deficit?
Gov spending> gov revenue
Why is a budget deficit expansionary?
Represents a net injection of demand into the circular flow of income
What is budget surplus?
When gov spending is less than gov revenue
Why is budget surplus contractionary?
Represents a net withdrawal from the circular flow of income
What is the main way a gov deficit is eliminated
Cut public spending or increase tax
What is done when taxes and cuts can’t fix a deficit?
Public sector borrowing
What is deficit financing?
Deliberately running in a budget deficit and borrowing to finance it
What is demand side fiscal policy?
Used to increase or decrease the level of AD through changes in gov spending, taxation and budget balance
What is the aim of deficit financing?
Stabilise economic cycle to achieve full employment without creating excessive inflationary pressures
What are the key 6 Keynesian views on fiscal policy?
-left to itself unregulated market economy leads to little economic growth, high unemployment and volatile business cycles
-a lack of AD caused by private sector tendency to save much and invest little can mean economy settles into under-full employment characteristics by demand-deficient unemployment
-by deliberate deficit financing the gov can use fiscal policy as a demand management instrument, inject demand and spending power into the economy to eliminate deficient AD and achieve full employment
-having met full employment gov can use fiscal policy in a discretionary way to fine tune level of AD
-fiscal policy orientated towards demand side of the economy, supply side treated as subordinate
-assumption gov spending has a high multiplier value.
What does a discretionary way mean?
Changing taxes and levels of public spending to meet new circumstances
Describe the Keynesian view that the gov spending multiplier has a high value?
If the national income multiplier is quite large with a respect to output an increase in gov spending (e.g 10 bill) increase real national income by 30 bill
-changing levels of gov spending, taxation and the budget deficit can be quite effective in managing AD(however real world multipliers are seen to be small)
What is fiscal orthodoxy?
Traditional view gov should balance their budgets
Who first legitimised deficit financing?
Keynes
What is expansionary fiscal policy?
Uses fiscal policy to increase AD and shift the AD curve to the right
AD equation
C-G+I+(X-M)
What does an increase in gov spending or cut in taxation to do AD
Increases size of budget deficit
-injection into the circular flow or income occurs and the effect on AD is expansionary
Diagram for expansionary or reflationary fiscal policy
Describe the diagram
Equilibrium at X
To increase demand-deficient(cyclical) unemployment gov increases spending or cuts taxes to increase the budget deficit
Shifts AD curve to the right new equilibrium of point Z
-however this creates excess demand that leads to demand pull inflation (p1-p2), the extent of which depends on the SRAS curve which itself depends on how close the economy was to its normal capacity level of output(y3)
The nearer the economy is to normal capacity of output, the greater the inflationary effect
What is contractionary fiscal policy?
Fiscal policy used to decrease AD and shift it to the left
How can this diagram show contractionary fiscal policy?
Cut in gov spending or increase in tax shifts AD to the left resulting in demand deflation and the price level falling
(The extent of which being dependent on the shape and slope of the SRAS)
What is discretionary fiscal policy?
Macroeconomic policy of fiscal policy used to manage the level of AD
What is a way govs can achieve full employment
Budget deficit, expands AD bit risks overheating economy and inflation
The larger the gov spending multiplier….
The smaller the increase in public spending ended to bring about a desired increase in national income
The larger the tax multiplier..
The smaller the required tax cut
Real world multiples are unlikely to be….
Much larger than 1 or unity
What do small multipliers mean?
Demand-side fiscal policy has relatively little effect on the level of AD and hence the economy
Process of crowding out:
Need to check this one
private and public spending is a trade off with the factors of production and available resources
(Increased gov spending decreases private spending)
What is the reason for the small gov spending multiplier
Process of crowding out
Diagram for the crowding out process
Describe this diagram
What is discretionary fiscal policy?
Involves making discrete changes to Gov spending and tax and budget deficit to manage AD
What is crowding out?
Situation where increase in gov or public sector spending displaces private sector spending with little or no increase in AD
What is supply-side fiscal policy?
Used to increase economy’s ability to produce and supply goods through creating incentives to work, save,invest and be entrepreneurial.
Interventionist supply side policies such as financing of retraining or schemes for unemployed workers are also designed to improve supply-side performance
What are supply side policies?
Gov economic policies which aim to make markets more competitive and efficient increase production potential and shift the LRAS to the right.
(Supply-side fiscal policy is the most important type of supply side policy but there is also non-fiscal supply-side policies )
Why to tax cuts increase AS?
Due to their effects on economic incentives
What is the aim of supply side fiscal policy?
Increase economy’s ability to produce and supply goods through creating incentives to work, save, invest and be entrepreneurial
What do supply side fiscal oldies do on a graph?
Try and shift LRAS to the right to increase the real national output of the economy
Diagram for affect of fiscal supply side policies
Good deflation here
But usually increases in LRAS are partnered with increase in AD leading to inflation most of the time
What does taxation actually do?
Raises revenue required to finance gov spending
Taxes and subsides can be used to alter relative prices of goods in order to change consumption patterns and promote investment by firms into new capital goods
What takes up most of gov expenditure?
Transfers(state pension and unemployment related benefits)
-interest payments and national debt
Total managed expenditure?
Total amount the gov spends-splits the amount that gov departments such as defence that have been allocated to spend and spending that is not controlled by a gov department, including welfare, pensions, national debt and interest payments.
Who are the office for budget responsibility?
Advisory public body that provides independent economic forecast and analysis of the public finances as background for the preparation of the uk budget
What takes the most gov spending
Social security(half of which on pensions-Triple lock)
What does the triple lock do?
Protect those receiving a pension from the effect of spending cuts
(Pensions rise with what is highest out of wages cpi or 2.5%
What happens to spending on social security when the economy boombs
Decreases as unemployment falls
What is an example of demand led spending?
Unemployment benefit (literally reliant on demand)
Expamples of transfer payments (gov expenditure)
State pension
Unemployment related benefits
What is debt interest made out of?
Payments from the gov to people who have lent to the state (rises when interest rates rise and vice versa)
If the national debt relative to gdp can be reduced what happens to debt interest as a fraction of nominal gdp?
It also falls(providing interest rates don’t rise)
