4.2.5 (Fiscal policy) Flashcards
Fiscal policy
The manipulation of govt spending, taxation and the budget balance
Govt spending and taxation
Govt can change the amount of spending and taxation to influence the economy.
In the UK, govt spends most of their money on benefits and pensions.
Expansionary fiscal policy
Aims to increase AD
- By govt increasing spending or reducing taxation.
- It may lead to worsening of the budget deficit.
Deflationary fiscal policy
Aims to decrease AD
- By govt cutting or raising taxes, which reduces consumer spending.
How does fiscal policy influence AS
- the govt could reduce corp tax to encourage spending & investments
- the govt could subsidise training or spend more on education - lowers cost fir firms, as train less workers
Budget deficit
when govt spending exceeds tax revenue
budget surplus
When tax revenue exceeds govt spending
Difference between debt and deficit
Govt debt is the accumulation of the govt deficit overtime - the amount the govt owes
The deficit is the difference between expenditure and revenue
Direct and indirect tax
Direct tax are imposed on income and paid directly to the govt (affects AD)
Indirect tax are imposed on expenditure on goods & services (affects SRAS)
Limitations of fiscal policy
- govt might have imperfect info about economy - lead to inefficient spending.
- time lags - could take months.
- if govt borrows from private sector this could lead to crowding out.
- if interest rates are high, fiscal policy might not be effective for increase AD
Reasons for public expenditure and levying tax
- current spending
- capital govt expenditure
- transfer payments
Current spending
Recurring spending
- goods and services for public services
Capital spending
State investments
- can be used multiple times
(Infrastructure)
Transfer payments
Welfare spending by the govt
- provide a min standard of living for those on low income.
- no goods or services are exchanged
Examples of transfer payments in the UK
- Income support
- Child benefit
- State pension
What reasons for the change in size of public expenditure in uK
In the UK govt spends most budget on pensions & welfare benefits then healthcare & education.
- education spending has remained constant, thus is bcuz its protected.
Fiscal drag
when tax brackets are frozen, so more taxpayers are dragged into higher tax brackets as their wages increase hence more taxpayers is paid
How does the UK finance a deficit
- By borrowing, through issuing bonds
What is the national debt
The total amount of money the govt owes
Each year the fiscal deficit is added to the national debt
How much does the UK spend on servicing the national debt
about 120 billion each yr
Key roles of fiscal policy
- influence the level of AD
- influence the level of AS
- influence the pattern of economic activity
- redistribute income and wealth
- provide a welfare safety net
How the multiplier can be used to justify expansionary fiscal policy
- A change in AD leads to greater increase in income
- multiplier effect means that an increase in net govt spending willl cause real output to increase
A cyclical fiscal deficit
Caused by a downturn in the economic cycle
- in a negative output gap, tax revenue falls (high U/P - less income tax - less output) so govt spending & welfare benefits rise
- in positive outpace gap, tax revenue rises (low U/P - high income tax - higher output
Structural deficit
The part of the budget deficit not caused by the economic cycle
- A structural exists even when the economy is booming
- it occurs due to discretionary fiscal policy (govt increasing govt spending)
- structural deficit is always being in deficit
