4.2.5 Fiscal policy and supply-side policies

Question 1

Define fiscal policy

Answer 1

the manipulation of government spending and taxation in order to influence aggregate demand and the level of economic activity

Question 2

What is a budget deficit?

Answer 2

when government spending is greater than taxation

Question 3

What is a budget surplus?

Answer 3

when taxation is greater than government spending

Question 4

What does PSDR stand for?

Answer 4

public sector debt repayment

Question 5

Define PSDR

Answer 5

the amount of debt the UK government can pay off in any one period

Question 6

What does PSNCR stand for?

Answer 6

public sector net cash requirement

Question 7

Define PSNCR

Answer 7

the amount that the government sector needs to borrow, over and above the tax revenue collected, to finance planned government spending

Question 8

Define direct taxes

Answer 8

taxes levied directly on incomes and profits

Question 9

Define indirect taxes

Answer 9

taxes levied on goods and services

Question 10

What are the 3 largest categories of government spending?

Answer 10

• social protection
• health
• education

Question 11

What does OBR stand for?

Answer 11

Office for Budget Responsibility

Question 12

Give 3 of the main responsibilities of the OBR

Answer 12

• economic and fiscal forecasting
• evaluating performance against targets
• evaluation of financial risk
• scrutinising tac and welfare policy costing
• balance sheet analysis

Question 13

Give 2 reasons why increasing the income tax rate past a certain point may decrease the tax revenue

Answer 13

• higher income tax rates decrease the incentive to work compared to lower rates
• higher tax rates can also lead to ‘brain-drain’ - where skilled workers begin to leave the economy

Question 14

Explain what is meant by ‘crowding-out’

Answer 14

increased borrowing by the government increases the rate of interest and reduces the funds available for private businesses to borrow and invest

Question 15

What is the supply of loanable funds based on?

Answer 15

based on savings

Question 16

What is the demand for loanable funds based on?

Answer 16

based on borrowing

Question 17

Give and explain 2 reasons why crowding out is unlikely to occur in a recession

Answer 17

• low business confidence - so businesses and firms are unlikely to be willing to invest anyway
• lots of spare capacity in a recession - so firms do not need to invest anyway

Question 18

Referencing interest rates, why may increased government borrowing lead to lower private spending and investment?

Answer 18

• increased government borrowing will lead to increased demand for loanable funds
• this increased demand for loanable funds pushes interest rates upwards
• increased interest rates can hold back private sector spending and investment

Question 19

Referencing spare capacity, why may increased government borrowing lead to lower private spending and investment?

Answer 19

• when governments borrow to invest, it can utilise all the remaining spare capacity in the economy
• leaving few factors of production left for the private sector to employ for investment and expansion purposes

Question 20

Referring to crowding out, why could it be argued that budget deficits are not desirable?

Answer 20

• budget deficits can be argued to be at the expense of private sector investment
• which can often be more productive than public sector investment

Question 21

List 3 points of evaluation for crowding out

Answer 21

• crowding out doesn’t occur in a recession
• governments could borrow from the world’s financial market
• ‘crowding-in’ effects

Question 22

Explain why if governments were to borrow from the world’s financial market, crowding-out would not be as much of an issue

Answer 22

• in the world’s financial market, the supply of money is relatively elastic
• thus borrowing here would not significantly increase UK interest rates that deter private sector investment

Question 23

Explain ‘crowding-in’ effects

Answer 23

• ‘spill-over effects’ from government investment
• technologies from government projects have applications in the private sector (e.g. GPS)

Question 24

What is meant by a structural budget deficit?

Answer 24

• it is a budget deficit that will not disappear even when the economy is on the upswing of the economic cycle
• the deficit isn’t linked to any stage of the economic cycle

Question 25

What is meant by a cyclical budget deficit?

Answer 25

it is a budget deficit that occurs as part of the business cycle

Question 26

Define austerity

Answer 26

government policies to reduce government spending or increase taxation, in order to reduce budget deficits and attempt to control growing public debt

Question 27

List 4 costs/negative of austerity

Answer 27

• can be self-defeating
• can cause some sectors to lose funding
• can reduce AD
• may lead to brain drain

Question 28

Explain how austerity can be self- defeating

Answer 28

• if in a recession, governments who cut spending hard will see a large fall in nominal GDP
• this will lead to a shrinking of tax revenues
• thus, austerity can reduce economic growth so much that the budget deficit fails to improve

Question 29

Explain how austerity could lead to some sectors being underfunded, and the effect this would have on the macroeconomy

Answer 29

• such as a drop in spending on education and training
• could reduce LRAS, lower the productive capacity of the economy

Question 30

Explain how austerity could lead to a reduction in AD, and the effect this would have on the macroeconomy

Answer 30

• increased taxes (a withdrawal) and decreased government spending (an injection) could reduce AD
• this could lead to increased unemployment, decreased national income, the negative multiplier, etc

Question 31

What is the KEY benefit of austerity?

Answer 31

reduces national debt

Question 32

List 3 benefits of austerity

Answer 32

• improves confidence
• reduces crowding-out
• reduces burden on future generations

Question 33

Explain how austerity could lead to increased confidence in the economy

Answer 33

• cutting budget deficits will give investors greater confidence about the long-term performance of the economy
• lower debt levels will encourage more private sector investment

Question 34

Explain how austerity reduces the burden on future generations

Answer 34

• if the national debt continues to grow, this will be passed onto the future generation in the forms of higher taxes
• thus austerity can help prevent this from happening

Question 35

List 2 points of evaluation for whether austerity is desirable or not

Answer 35

• the current level of business confidence
• the current state of the economy

Question 36

Explain why the benefits/costs of austerity depend on the current level of business confidence

Answer 36

if there is high business confidence, austerity would be more desirable as lower government spending would be met with greater private sector spending

Question 37

Explain why the benefits/costs of austerity depend on the current state of the economy

Answer 37

• if in a recession, austerity is likely to just decrease AD, which is not beneficial
• however, it would be beneficial for when the economy is overheating

Question 38

Define market-based supply-side policies

Answer 38

policies that remove or reduce government intervention and promote greater free market operation

Question 39

Define interventionist supply-side policies

Answer 39

policies that increase government intervention in the market through greater use of government spending, taxation or regulation

Question 40

The difference between the natural rate of unemployment and the unemployment rate is caused by what?

Answer 40

the business cycle

Question 41

Approximately, what is the natural rate of unemployment in the UK?

Answer 41

4 - 5 %