4.5 role of the state in macroeconomy Flashcards
1
Q
what are the types of government expenditure?
A
Capital government expenditure, General government final consumption, Transfer payments, current government expenditure
2
Q
what is capital government expenditure?
A
spending on investment goods such as new roads, schools and hospitals which will be consumed in over a year.
3
Q
what is general final consumption?`
A
spending on goods and services that will be consumed within the next year, such as public-sector salaries
4
Q
what is transfer payments?
A
government payments for which there is no corresponding output, where money is taken from one group and given to another, for example benefits and pensions.
5
Q
what is current government expenditure?
A
general government final consumption plus transfer payments plus interest payments.
6
Q
how much of the expenditure is spent on defence?
A
6% is spent on defence
7
Q
how much of the expenditure is spent on protection?
A
4% is spent on protection
8
Q
how much of the expenditure is spent on education?`
A
12% is spent on education
9
Q
how much of the expenditure is spent on pensions?
A
20% is spent on pensions
10
Q
how much of the expenditure is spent on welfare?
A
15% is spent on welfare
11
Q
how much of the expenditure is spent on transport?
A
2% is spent on transport
12
Q
how much of the expenditure is spent on health care?
A
18% is spent on healthcare
13
Q
how much of the expenditure is spent on interest repayments?
A
7% of all government spending is on interest repayments of loans.
14
Q
what is the relationship between average income and government expenditure and why?
A
the lower the average income of the country, the lower is likely to be the percentage of GDP spent by the government. this is due to the fact that poorer countries have lower tax revenue (inefficient collection, small amounts of wealth to tax, avoidance). higher income countries usually demand more from government
15
Q
what is the US public spending like?
A
USA has much lower state spending, and
this is due to attitudes in that country.
16
Q
what is the effect of the global financial crisis on government expenditure?
A
the global economic crisis has increase government expenditure as there are increased welfare payments and some countries needed to bail out the banks for example the government bailed out Lloyds bank and the bank of Scotland
17
Q
what is austerity?
A
a set of economic policies, usually consisting of tax increases, spending cuts, or a combination of the two, used by governments to reduce budget deficits.
18
Q
how does government policy affect government spending?
A
policies such as austerity will reduce the expenditure so the amount of spending by the government may depend on policies and targets set by the government
19
Q
what is a demographic change that affects government expenditure?
A
an aging population will put more pressure on government expenditure as there will be a greater number of pensions and larger amount of care needed
20
Q
give an example of a demographic change affecting expenditure by governments
A
aging population is becoming an issue in Japan and Europe
21
Q
what are the impacts of government expenditure?
A
Productivity and growth, Living standards, Crowding out, Level of taxation, Equality
22
Q
what is the pros of government expenditure on productivity and growth?
A
the government can improve education -increase human capital, they can increase healthcare -productive workers, they can use their economies of scale when providing goods- increased productivity, they can do research and development which may not be done by private (positive externality), they can use multiplier effect to target areas of high unemployment - increased growth
23
Q
what are the cons of government expenditure on productivity and growth?
A
Free market economists argue that government spending is wasteful and causes inefficiency.
24
Q
what are the pros of government expenditure on living standards?
A
government corrects market failure and provides public goods , which improves social welfare. they also reduce absolute poverty by providing benefits and basic goods such as education and healthcare
25
what are the cons of government expenditure on living standards?
the government may be inefficient at providing goods and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall. government suffers from the principal agent problem since they make decisions on behalf of the people and individuals may have spent
that money differently therefore there is a welfare loss and a fall in living standards.
26
what is the crowding out affect?
when government spending fails to increase overall aggregate demand because higher government spending causes an equivalent fall in private sector spending and investment.
27
how does government expenditure create the crowding out effect?
if a governments wants to spend above the tax revenue, they then are competing with firms for funding. this will push up the interest rate which will discourage investment by firms and consumption by credit. the limited number of resources also mean that any resources used by governments cant be used by private sector therefore crowding out private investment which may lead to no real improvement in AD
28
when is the crowding effect most impactful?
The crowding out effect is felt most at full employment
29
why might government expenditure not impact the crowding out effect?
Transfer payments would not cause crowding out
as resources are simply taken from one group and given to another; the government isn’t taking resources from the economy. also when levels of unemployment
are high then extra government spending could lead to crowding in where it encourages investment through the multiplier.
30
how does government expenditure affect the level of taxation?
where government spending is high, levels of tax must be high in order for spending to be sustainable. High levels of tax may have a disincentive effect. the exception is oil rich countries such as Saudi Arabia, where revenue from oil can pay for government spending
31
how does government expenditure effect equality?
Spending should increase equality as it leads to redistribution and helps to provide a minimum standard of living for the poorest in society. It ensures everyone has access to basic goods, such as education and healthcare, which will help to give them a fair start in life.
32
what are Adam Smiths 4 canons of taxation?
1- equity (taxes proportional to income) 2- certainty ( timing and amount should be known) 3- convenience ( timing and collection is convenient with tax payer) 4- economy ( costs of collecting tax are minimized)
33
what are the UKs aims of taxation?
keeping the burden of tax low, improving incentives, using equitable taxes, correcting market failure and taxing spending rather than income.
34
what are the uses of taxes?
used to pay for the number of goods and services that the government provides, used to correct market failure at a microeconomic level and to manage the economy and redistribute income at a macroeconomic one.
35
what is a progressive tax?
those who are on higher incomes pay a higher marginal rate of tax; they pay a higher percentage of their income on tax. Direct taxes tend to be progressive, for example income tax
36
what is a regressive tax?
where the proportion of income paid in tax falls as the income of the taxpayer rises. Those on higher incomes pay a smaller percentage of their income on the tax.
37
what is a proportional tax?
where the proportion of income paid on tax remains the same whilst the income of the taxpayer changes. Everyone pays the same percentage of their income on the tax.
38
what are the impacts of tax changes?
Incentives to work, Tax revenues, Income distribution, Real output and employment, Price level, Trade balance, FDI flows
39
how do changes in taxation affect the incentive to work?
high marginal rates of tax will discourage individuals from working. as the supply of labour is inelastic, a reduction in marginal taxes will lead to a significant increase in work. higher taxes may encourage high income earners to move abroad. switch from direct to indirect tax would increase incentive to work.
40
what evidence may counter the impact changes on taxation has on the incentive to work?
Nordic countries have high taxes and welfare benefits but have similar rates of growth compared to lower tax and government spending countries like US and UK
41
what is the counter to lower incentive to work when taxes are high?
It can be argued that higher taxes mean people have to work longer hours in order to maintain their income and so even increases the incentive work.
42
what is the laffer curve show?
it shows that as tax rate increases tax revenue will increase until its optimal point where revenue is maximised then it will fall again. it is an inverted U shape.
43
when is the tax revenue 0?`
at 0% and 100% as people arent paying any tax at 0% and unwilling to work at 100%
44
why does tax revenue fall after the optimal tax rate is exceeded?
the motivation and drive is reduced so output will fall, the opportunity cost of leisure is reduced, there will also be an increased incentive to use tax avoidance and evasion.
45
why is tax revenue from indirect tax uncertain?
Revenue from indirect taxes can be uncertain as they depend on consumer spending patterns.
46
how do tax changes affect the income distribution?
progressive taxes will increase equality whereas regressive will increase inequality. therefore a move from indirect taxes to direct taxes will therefore increase equality. inheritance tax is most progressive tax and transfers wealth from rich to poor.
47
what is the issue with using tax changes to solve the income distribution?
just using taxes by themselves will not solve inequality, it needs to be supported by government benefits
48
what is the effect on rise of direct taxes on real output and employment?
A rise in direct taxes will reduce the level of disposable income an individual has, which will cause a fall in their spending and thus a fall in AD. It could also cause a fall in leftover profits for businesses and therefore a fall in investment.
49
what is the effect on rise of indirect taxes on real output and employment?
higher indirect taxes and NICs increase costs for firms and this will decrease SRAS.
50
what is the effect on rise of income taxes on real output and employment?
It can be argued that income taxes cause a disincentive to work and therefore reduce LRAS as the most skilled workers go overseas and more people become inactive.
51
what is the effect on price level of a change in taxation?
taxes can impact LRAS, SRAS and AD. Therefore, these
changes will impact price depending on where the economy is producing. Indirect taxes, particularly VAT, often cause cost push inflation.
52
what is the effect on the trade balance of a change in taxation?
A rise in taxes will decrease income and therefore decrease consumption, theoretically this will also mean consumers spend less on imports . Imports in the
UK have been found to be highly income elastic. As a result, the trade balance will improve in the short run. However, in the long run, lower AD will reduce businesses’ need to invest and this could reduce competitiveness meaning that exports decrease.
53
what is the effect on FDI flows of a change in taxation?
Low taxes on profit and investment tend to encourage businesses to invest in a country since it will help them to see a higher level of return.
54
what is the issue with changes on taxation for FDI?
The problem with this is that it can be a ‘race to the bottom’ where countries have to continue to lower their taxes in order to make them the lowest to encourage investment; the eventual result is a fall in revenues for all countries.
55
what are automatic stabiliser?
Automatic stabilizers are mechanisms which reduce the impact of changes in the economy on national income; government spending and taxation are automatic stabilizers. In a recession, benefits increase as more people are unemployed and so the benefits are a stabilizer as it means that the overall fall in AD is reduced, preventing too much change in the economy. On the other hand, during a boom, tax increases as people have more jobs and higher incomes, and this tax reduces disposable income so decreases consumption and AD, meaning that demand doesn’t grow too high.
56
what is discretionary fiscal policy?
Discretionary fiscal policy is the deliberate manipulation of government expenditure and taxes to influence the economy; expansionary and deflationary
policies.
57
what are evaluation points for automatic stabilisers?
These automatic stabilizers cannot prevent fluctuations; they simply reduce the size of these problem and there can be negative aspects to these stabilizers. Benefits may act as a disincentive to work and lead to higher unemployment whilst high levels of tax can decrease the incentive to work hard.
58
what is the national debt?
The national debt is the sum of all government debts built up over many years
59
what is a fiscal defecit?
a fiscal deficit is when the government spends more than it receives that year.
60
why is debt measured in gdp usually better than in money terms?
The GDP measure is often more useful because it gives an indication of how easy to will be for the government to finance a deficit or repay the national debt.
61
what is the public sector net cash requirement?
the total money that the government needs to borrow in order to fulfil its spending plans. it is the difference between revenue and spending
62
what is a cyclical defecit?
A cyclical deficit is the part of the deficit that occurs because government spending and tax fluctuates around the trade cycle. When the economy is in recession, tax revenues are low and spending is high creating a larger deficit.
63
what is a structural defecit?
At the peak of the boom, there is no cyclical deficit; any deficit at this point is a structural deficit. The structural deficit is the fiscal deficit which occurs when the cyclical deficit is zero; it is long term and not related to the state of the economy
64
what is the actual defecit?
The actual deficit is the structural deficit plus the fiscal deficit.
65
when does a structural surplus occur?
A structural surplus occurs when at the peak of the boom, there is an actual fiscal surplus
66
when does a structural balance occur?
a structural balance occurs when at the peak of the boom, the actual fiscal balance is 0.
67
what happens to national debt when there is a structural defecit?
If the government has a structural deficit, it is likely that national debt will grow over time as the government has to consistently borrow money to finance spending.
68
why is it difficult to deal with structural defecit?
this is difficult since it is impossible to know what part of the deficit is structural and what part of it is cyclical, just as it is impossible to know the size of the output gap
69
what are the factors that affect the size of the fiscal defecit?
trade cycle, unforeseen events, interest rates, privatization, government aims, high revenue from oil, number of dependents
70
how does the trade cycle affect the size of the fiscal deficit?
During a downturn, government tax revenue decreases whilst government spending increases and so the deficit increases.
71
how does unforeseen events affect the size of the fiscal deficit?
Unforeseen events, such as natural disasters or recessions, lead to huge increases in spending which increase the deficit.
72
how does interest rates affect the size of the fiscal deficit?
If interest rates on government debt increase, the amount the government pays in interest repayments increases and this is likely to increase the deficit. The impact of this will depend on how significant interest repayments are in the size of the deficit. Interest rates depend on market rates and the credit ratings of the government.
73
how does privatization affect the size of the fiscal deficit?
Events like privatization provide one-off payments to the government which will decrease the deficit in the short term; it will depend on the value of the company sold.
74
how does government aims affect the size of the fiscal deficit?
Government aims are important in the size of the deficit, as this will influence their fiscal policy, for example the austerity aim has helped to decrease the size of the deficit but attempting to increase AD would increase spending
75
how does high revenues from oil affect the size of the fiscal deficit?
Many countries with high revenues from oil , for example the OPEC countries, run a budget surplus and so government revenue is important in the size of the deficit.
76
how does the number of dependents affect the size of the fiscal deficit?
Factors such as the number of dependents in a country affect both spending and tax revenues so influence the deficit.
77
what are factors that affect the size of national debts?
continuous fiscal deficits, aging populations
78
how does continuous fiscal deficits affect the size of the national debt?
If the government is continuously running a deficit, then the national debt will increase overtime. There is a consensus view that fiscal deficits over 3% will lead
to growing national debt as a proportion of GDP . It is only when the government runs a budget surplus that the size of the national debt decreases.
79
how does an aging population affect the size of the national debt?
Ageing populations tend to contribute to a high national debt since the government runs a structural deficit in order to fund their pensions and care and this leads to a high national debt.
80
what is the effect of the national debt on the interest rate?
High levels of borrowing may raise interest rates in the economy since an increase in the demand for money will increase the price of money, i.e. interest rates. This could cause crowding out of the economy.
81
what is the effect of the national debt on the cost of servicing the debt?
Countries have to spend a large amount of money on servicing their national debt through interest repayments, which has a high opportunity cost. The UK spends £70 billion a year to service its debts but this is small as a percentage of GDP . A primary budget deficit is the actual budget deficit but does not include interest repayments on the national debt.
82
what is the effect of national debt on intergenerational inequality?
Some economists argue that high fiscal deficits and national debts benefit citizens today at the expense of future generations and can cause intergenerational inequality. A current budget deficit is problematic as it means that future generations are forced to pay the bill for today’s expenditure.
83
what is an evaluation for the effect of national debt on intergenerational inequality?
The concerns over a deficit depend on whether the deficit is caused by current expenditure alone or whether it is just caused by capital expenditure. if the deficit is due to capital expenditure, the future generations benefit from increased spending and so their extra tax bill to pay for today’s borrowing can be justified. The value of debt tends to fall overtime because inflation erodes its value and because a country’s GDP grows meaning the debt is easier to pay off, so this limits the impact on future generations.
84
what is an evaluation point for the effect of the national debt on the cost of servicing the debt?
The impact will depend on the level of interest rates and the size of the primary deficit compared to interest repayments. In a liquidity trap (when interest rates are extremely low), the government can often borrow at very low rates for long periods of time.
85
what is the evaluation point for the effect of the national debt on the interest rate?
crowding out may not always be the case as the government may borrow from overseas and during a recession, private sector investment falls which means interest rates may remain unchanged.
86
what is the effect of high fiscal deficits on inflation?
High fiscal deficits can cause inflation. If the government increases their spending and there is no similar fall in private sector spending, AD will rise and this can be inflationary. More dangerously, if a government is unable to borrow money, they will
print more money and this can cause hyperinflation as in Germany in 1923 or Zimbabwe in 2008 .
87
what is the evaluation point for high fiscal deficits on inflation?`
Printing money will not necessarily cause hyperinflation, it depends on how much is printed and where the economy is producing on the LRAS.
88
what is the effect of national debt on the governments credit rating?
High levels of debt tend to result in a reduced credit rating for the government. Private sector companies estimate the likelihood that a government will default on its debt and give it a rating from AAA to D. Lower credit ratings mean that lending to the government is riskier and so higher interest rates are demanded from lenders.
89
what is the evaluation point for the effect of the national debt on governments credit rating?
in reality, it is not the size of the debt that influences the level of risk involved with the lending the money, it is whether that country has ever defaulted on their loans before and their current economic/political climate.
90
what is the effect of national debt on the governments foreign currency reserves?
If a government has borrowed from abroad, it may have difficulties getting enough foreign currency to make repayments on its debt. This could also cause problems for consumers as if there is not enough foreign currency, they will be unable to import goods.
91
what is the effect of government borrowing on growth?
government borrowing can benefit growth if it used for capital spending since this will improve the supply side of the economy and thus reduce the deficit in the long term. On top of this, the budget deficit can be used as a tool for short term demand management: Keynesians argue a deficit is acceptable to use as a stimulus in demand during recessions.
