4.2.5 Fiscal and Supply Side Policies Flashcards
Fiscal policy
Involves the manipulation of government spending, tax and the budget balance. Aims to stimulate growth and stabilise the economy
Expansionary fiscal policy
Aims to increase AD, government increase spending or reduce tax. This worsens the government budget deficit
How is expansionary fiscal policy shown on a diagram
Outward shift in AD
Increases GDP and price level
Deflationary fiscal policy
Aims to decreases AD. Government cuts spending or raises taxes, which reduces consumer spending. Improves government budget deficit
How can deflationary fiscal policy be shown on a diagram
Inward shift in AD
Lower GDP and price
Limitations of fiscal policy
- government might have imperfect information
- time lag
- if the government borrows from the private sector, there are fewer funds available for the private sector and could lead to crowding out
- if there is a small multiplier there will be a small affect on AD
- if interest rates are high fiscal policy may not raise AD
- could lead to large debts, making it difficult to borrow in the future
Difference between government deficit and debt
Debt is built up by continuous running of a deficit
Budget deficit
When expenditure exceeds tax
Direct taxes
Imposed on income and paid directly from tax payer to government (income tax, corporation tax, inheritance tax)
How can fiscal policy influence AS
- reduction in tax encourages spending and investment
- government could subsidise training or spend more on education
- government could spend more on infrastructure
Indirect tax
Imposed on expenditure on goods and services, they increase costs and therefore prices
Ad valorem
Percentage taxes (VAT 20%)
Specific taxes
A set tax per unit (58p per litre of petrol)
Proportional tax
Where everyone pays the same proportion of their income
Progressive tax
Richer people pay higher percentage (income tax)
Regressive tax
Where poorer people pay a higher percentage of their income (ad valorem taxes like VAT)
Current government expenditure
This is on goods and services which are consumed and last a short period of time (drugs)
Capital government expenditure
Spent on assets, which can be used multiple times (roads or schools)
Transfer payments
Welfare payments from the government e.g Job seekers allowance Income support Child benefit State pension
Cyclical deficit
A temporary deficit which is related to the business cycle. A deficit may occur in a recession when the government is trying to stimulate the economy
Structural deficit
Due to imbalance of revenue and expenditure of the government
Consequences of budget deficits
- a fiscal deficit could be inflationary if AD rises
- more government spending leads to crowding out of the private sector
- could lead to increased interest rates
Significance of national debt
- cost of borrowing increases
- government may have to raise interest rates to encourage investors to buy bonds
- could lead to higher taxes and austerity measures
Role of office for budget responsibility
- provides analysis of UK’s finance
- produce 5 year forecasts
- judge the government’s performance against its fiscal targets
- they scrutinise tax and welfare spending
- they assess how sustainable public sector finances are in the long run
Supply side policies
Aim to improve long run productive potential of the economy
Pros and cons of supply side policies
✅ only policies that can deal with structural unemployment because the labour market can be improved by education
❌demand side policies deal better with cyclical unemployment
❌time lag
❌market based supply side policies could worsen distribution of income
Examples of free market supply side policies
Tax cuts
Deregulation
Privatisation
Labour market reforms
How can free market supply side policies increase incentives?
By reducing income and corporate tax, work is incentivised as well as spending and investment, long run productive potential increases
How do free market supply side policies promote competition
By deregulating or privatising the public sector, firms can compete in a competitive market which helps improve economic efficiency
How can free market supply side policies reform the labour market
Reducing the NMW will allow free market forces to allocate wages and the labour market should then clear
Examples of interventionist supply side policies
Government spending on education
Industrial policies
Subsidising R and D
Aims of free market supply side policies
To increase incentives
To promote competition
To reform the labour market
Aims of interventionist supply side policies
To promote competition
To reform the labour market
Improve skills of the labour force
Improve infrastructure
How can interventionist supply side policies help promote competition
A stricter government competition policy could help reduce monopoly power and ensure smaller firms can compete
How can interventionist supply side policies reform the labour market
Subsiding then relocation of workers and improving availability of job vacancy information helps mobility of labour
How can interventionist supply side policies improve skills of the labour force
Subsiding training lowers costs of production for firms. Spending more on healthcare improves quality of labour
How can interventionist supply side policies improve infrastructure
Government spending on schools and roads
