4.5 Role and State of Macroeconomy

Question 1

What is the primary purpose of government spending?

Answer 1

To control aggregate demand (AD) and achieve macroeconomic objectives: economic growth, low and stable inflation, balanced current account, and low unemployment

Government spending also aims for equity and equality by providing services to those who would not otherwise receive them.

Question 2

What are the types of government expenditure?

Answer 2

• Capital government expenditure
• General government final consumption
• Transfer payments
• Interest payments for national debt

Question 3

What percentage of government spending is allocated to pensions?

Answer 3

20%

Question 4

What is the relationship between a country’s average income and government spending?

Answer 4

In most mixed and free economies, lower average income usually correlates with a lower percentage of GDP spent by the government.

Question 5

What impact did the Global Financial Crisis have on government spending?

Answer 5

It led to huge increases in government spending as welfare payments rose and some governments used taxpayer money to bail out banks.

Question 6

What is the crowding out effect in government spending?

Answer 6

Government borrowing competes with the private sector for finance, potentially leading to higher interest rates and discouraging private investment.

Question 7

True or False: Transfer payments cause crowding out.

Answer 7

False

Question 8

What is a progressive tax?

Answer 8

A tax where those on higher incomes pay a higher marginal rate of tax.

Question 9

What is a regressive tax?

Answer 9

A tax where the proportion of income paid in tax falls as the income of the taxpayer rises.

Question 10

What is the Laffer curve?

Answer 10

A theory that shows a rise in tax rate does not necessarily increase tax revenue, indicating an optimal tax level that maximizes revenue.

Question 11

What are automatic stabilisers?

Answer 11

Mechanisms that reduce the impact of changes in the economy on national income, such as government spending and taxation.

Question 12

What is the difference between a fiscal deficit and national debt?

Answer 12

A fiscal deficit occurs when the government spends more than it receives in a year, while national debt is the sum of all government debts built up over many years.

Question 13

What is the distinction between structural and cyclical deficits?

Answer 13

• Cyclical deficit: Occurs due to fluctuations in government spending and tax related to the trade cycle
• Structural deficit: Long-term deficit not related to the state of the economy

Question 14

What is the impact of high marginal tax rates on individual work incentives?

Answer 14

High marginal tax rates can discourage individuals from working.

Question 15

Fill in the blank: A _______ tax system will increase the equality of income distribution.

Answer 15

progressive

Question 16

What is a key argument against government spending in terms of efficiency?

Answer 16

Free market economists argue that government spending is wasteful and that investment would be more efficient if done by the private sector.

Question 17

What can high taxes on high-income earners lead to?

Answer 17

Encouragement to move abroad.

Question 18

What is discretionary fiscal policy?

Answer 18

The deliberate manipulation of government expenditure and taxes to influence the economy.

Question 19

How do tax changes affect aggregate demand (AD)?

Answer 19

A rise in direct taxes reduces disposable income, leading to a fall in spending and thus a fall in AD.

Question 20

What is a structural deficit?

Answer 20

A structural deficit occurs when a government’s ongoing spending exceeds its revenues, leading to a need for borrowing over time.

It is difficult to distinguish between structural and cyclical deficits.

Question 21

What major factor influences fiscal deficits during economic downturns?

Answer 21

The trade cycle influences fiscal deficits, where tax revenue decreases and spending increases during downturns.

This leads to an increase in the fiscal deficit.

Question 22

What was the peak fiscal deficit in the UK in 2010 as a percentage of GDP?

Answer 22

10.1% of GDP.

This represents a significant fiscal deficit during that period.

Question 23

How do unforeseen events impact fiscal deficits?

Answer 23

Unforeseen events, such as natural disasters or recessions, lead to increased government spending, thereby increasing the deficit.

Question 24

What role do interest rates play in the fiscal deficit?

Answer 24

Increased interest rates on government debt lead to higher interest repayments, which can increase the fiscal deficit.

7% of all UK government spending is on interest repayments.

Question 25

What is the impact of privatisation on fiscal deficits?

Answer 25

Privatisation can provide one-off payments to the government, decreasing the deficit in the short term depending on the value of the sold company.

Question 26

What is the relationship between fiscal deficits over 3% and national debt?

Answer 26

Fiscal deficits over 3% are likely to lead to growing national debt as a proportion of GDP.

Question 27

What demographic factor contributes to high national debt?

Answer 27

Ageing populations contribute to high national debt due to the need for pensions and care funding.

Question 28

What is a primary budget deficit?

Answer 28

A primary budget deficit is the actual budget deficit excluding interest repayments on the national debt.

Question 29

How can high fiscal deficits lead to inflation?

Answer 29

If government spending increases without a corresponding decrease in private sector spending, aggregate demand rises, which can be inflationary.

Question 30

What is the consequence of a government printing money during a deficit?

Answer 30

Printing money can lead to hyperinflation, as seen in historical cases like Germany in 1923 or Zimbabwe in 2008.

Question 31

What contributes to a reduced credit rating for a government?

Answer 31

High levels of debt tend to result in a reduced credit rating, making lending riskier and leading to higher interest rates demanded by lenders.

Question 32

What is one potential benefit of government borrowing?

Answer 32

Government borrowing can stimulate growth if used for capital spending, improving the supply side of the economy.

Question 33

What fiscal policy has the UK government used since 2010 to reduce national debt?

Answer 33

The UK government has implemented a policy of austerity to decrease spending.

Question 34

What are automatic stabilisers in fiscal policy?

Answer 34

Automatic stabilisers are mechanisms that automatically adjust government spending and tax revenues to stabilize the economy without additional intervention.

Question 35

What is a progressive tax system?

Answer 35

A progressive tax system is one where higher income earners pay a larger percentage of their income in taxes, aimed at reducing income inequality.

Question 36

What are means-tested benefits?

Answer 36

Means-tested benefits are financial assistance provided only to individuals with low income or wealth, targeting those in greatest need.

Question 37

What is the purpose of equal pay legislation?

Answer 37

Equal pay legislation aims to prevent wage inequality between men and women or different ethnic groups.

Question 38

What is the law of diminishing marginal utility?

Answer 38

The law of diminishing marginal utility states that as a person consumes more of a good, the additional satisfaction gained from consuming each additional unit decreases.

Question 39

What is quantitative easing?

Answer 39

Quantitative easing is a monetary policy where a central bank purchases government securities to increase the money supply and encourage lending and investment.

Question 40

How can the government improve international competitiveness?

Answer 40

By increasing productivity and flexibility through supply-side measures, education, and deregulation.

Question 41

What is the effect of a commodity price shock on the economy?

Answer 41

A commodity price shock can lead to increased inflation or reduced GDP, which the government may address through expansionary or deflationary policies.

Question 42

What is the impact of political instability on the economy?

Answer 42

Political instability can negatively affect economic performance and may require government intervention to stabilize the economy.

Question 43

What was the reason for lowering interest rates?

Answer 43

To improve confidence

Question 44

What action was taken regarding interest rates to deal with inflation?

Answer 44

Raised

Question 45

How much has the chancellor set aside to deal with the effects of Brexit?

Answer 45

Around £3bn

Question 46

What is the estimated spending to leave the EU?

Answer 46

Around £35bn

Question 47

What can changes in exchange rates cause within a country?

Answer 47

Inflation or fall in growth

Question 48

What negative impacts can transnational companies (TNCs) have?

Answer 48

* Destroy local culture * Affect the environment * Withdraw more in profits than they inject

Question 49

What is illegal for TNCs operating in the EU and the USA?

Answer 49

Using bribery or corrupt practices

Question 50

What requirement may some developing countries impose on TNCs?

Answer 50

Set up a joint company with a local partner

Question 51

What is transfer pricing?

Answer 51

A method for firms to engage in tax avoidance by manipulating prices between subsidiaries

Question 52

What is the overall aim of a firm using transfer pricing?

Answer 52

Increase profit in a low tax country and decrease it in a high tax country

Question 53

What guidelines were introduced by the OECD in 1995 regarding transfer pricing?

Answer 53

Transfer Pricing Guidelines

Question 54

What principle do the Transfer Pricing Guidelines aim to uphold?

Answer 54

Arm's length principle

Question 55

Why is it difficult for individual governments to control TNCs?

Answer 55

Small countries may earn less in revenue than TNC profits

Question 56

What are the 'Dutch sandwich' and 'double Irish'?

Answer 56

Legal tax avoidance schemes used by TNCs

Question 57

What is a major challenge in finding solutions to taxation issues involving TNCs?

Answer 57

Requires worldwide agreement

Question 58

What type of information can hinder policymakers?

Answer 58

Inaccurate short-term information

Question 59

What is a major risk for governments in decision making?

Answer 59

Inability to accurately predict the future

Question 60

What are external shocks?

Answer 60

Uncontrollable events that impact the economy

Question 61

What can Brexit potentially undermine?

Answer 61

Current government policies