4.5 Role Of The State In The Macroeconomy Flashcards
1
Q
types of govt. expenditure
A
- capital expenditure; on investment goods, e.g. roads, schools, hospitals
- current expenditure; daily payments required to run the govt. and public sector, e.g. wages of public employees and payments for goods consumed in the short-run such as medicines for the NHS
- transfer payments; govt. payments for which there’s no corresponding output, e.g. benefits and pensions
2
Q
size and composition of public expenditure
A
- healthcare (20%)
- pensions (16%)
- welfare (13%)
- education (9%)
- interest repayments of loans (7%)
- defence (5%)
- transport (4%)
- protection (4%)
- other spending is around 18%
3
Q
factors affecting the size and composition of public expenditure
A
- changing incomes; a rise in income decreases demand for public services as people may instead choose to pay for privately provided services, e.g. private healthcare
- demographics (changing age distributions); rise in life expectancy means more govt. spending on pension payments and healthcare
- changing expectations; as societal norms change, expectations change, putting pressure on govts. to change their services, thus resulting in increased spending, e.g. NHS patients wanted online access to their medical records and the govt. spent significant sums on creating the platform to do that. similar example of money spent on NHS COVID app during the pandemic
- GFC; UK govt. borrowing significantly increased to facilitate the govt. spending required to avoid a long-lasting depression, but this borrowing had to be repaid with interest, and in the years following the crisis, the UK govt. followed a policy of austerity to cut their expenditure and raise taxes
4
Q
level of public expenditure as a proportion of GDP
A
varies between economies, e.g. in 2021, it accounted for;
* 44% of UK GDP
* 42% of USA GDP
* 59% of France GDP
* 30% of India GDP
5
Q
impacts of public expenditure
A
- productivity and growth;
- govt. can use expenditure on g&d policies which can improve the supply-side of the economy through spending on infrastructure, health, education, etc.
- critics believe it’ll inhibit growth as the state will inefficiently use resources that have been taken away from the private sector
- living standards;
- expenditure improves this as money has been spent to improve development and quality of life, but it may create opportunity for corruption which can reduce standards of living
- taxation;
- increase in expenditure means rise in taxes to fund the govt. spending
- national debt;
- if taxes aren’t raised, a rise in expenditure must be funded through increased borrowing and debt to balance out the budget
- crowding out;
- when govt. spending reduces the amount the private sector can spend due to higher IR, e.g. after buying bonds and increasing IR to increase demand for them
- equality;
- transfer payments and proportional tax systems even up income distribution, but if the spending isn’t spread evenly throughout the whole country, it can create inequality of opportunity, e.g N / S divide in UK
- innovation;
- drives innovation by providing long-term seed funding for firms and investing in applied research
6
Q
different tax systems
A
- progressive; direct taxes; they increase with income so high-income households pay a larger % of tax
- regressive; indirect taxes; they don’t increase with income, so low-income households are worse off as a larger % of their income is paid in taxes
- proportional; constant % of income paid; used in Bolivia where tax rate is 13% for everyone
7
Q
economic effects of changes in tax rates
A
- incentives to work; higher the tax rate, lower the incentive for unemployed to seek work or for existing workers to work overtime
- tax revenues; as tax rates rose, a point will be reached where it disincentivises workers to work, resulting in less income and less govt. revenue (Laffer curve - diagram 1)
- income distribution; progressive system redistributes from higher income to lower income, thus reducing inequality, but sometimes these benefits are eroded through impact of regressive taxes
- real output and employment; if tax rate rises, more money is withdrawn from the circular flow of income, reducing AD which may increase unemployment levels
- price level; a rise in indirect taxes increases production costs for firms which can reduce SRAS and cause cost-push inflation, and they reduce disposable income so workers may petition for wage increases, but the economy may face a wage-price spiral, where higher wages lead to further cost-push inflation
- trade balance (X-M); increase in taxes can reduce disposable income which is likely to reduce the level of imports, thus improving the trade balance. however, lower AD in the long-run will reduce investment which can reduce competitiveness of exports
- FDI flows; low taxes on profit encourages investment as businesses will see a higher rate of return, and if corporation tax rate rises relative to other countries, there will be less inward FDI as investors lose more money to taxes
8
Q
difference between automatic stabilisers and discretionary fiscal policy
A
- automatic stabilisers; automatic fiscal changes which increase govt. spending and reduce taxes during a recession and vice versa during a boom, e.g. people’s incomes often fall in recessions, so they’ll automatically pay a lower tax rate, or automatic rises in welfare benefits when unemployment is rising (unemployment insurance)
- discretionary fiscal policy; a demand-side policy involving the deliberate manipulation of govt. expenditure and taxes to influence AD
9
Q
difference between fiscal debt and national debt
A
- fiscal (budget) deficit; occurs when govt. expenditure > govt. revenue in any given year (5% of GDP)
- national debt; the accumulation of all previous deficits (99% of GDP)
10
Q
difference between structural and cyclical deficits
A
- cyclical deficits; occur due to downturns in the trade cycle as a result of recession - govt. recieve less tax revenue as profits / income fall, but govt. spending rises as they implement expansionary fiscal policies - these deficits self-correct as the economy grows again
- structural deficits; long-term which occur when cyclical deficit is 0 as it’s present even when an economy is operating at full employment level of output - hard to correct, may be caused by widespread tax avoidance culture, and likely to increase national debt over time
11
Q
factors influencing the size of fiscal deficits
A
- state of the economy; fiscal deficits increase during a recession as govt. revenue falls and govt. spending increases
- housing market; deficit decreases when an economy is doing well as the govt. receives indirect tax from property sales (stamp duty)
- political priorities; after rescuing UK after GFC, UK prioritised austerity with the focus of eliminating the deficit
- unforeseen events; many unforeseen events that require govt. support, e.g. Russia-Ukraine War led to £2.8bn spent in aiding from the UK
- interest rates; higher IR on govt. debt will increase the amount they pay which worsens the deficit
12
Q
factors influencing the size of national debts
A
- size of fiscal deficits; the larger the fiscal debt, the worser the level of national debt will be as it’s an accumulation of it - UK running a budget surplus would help reduce it
- govt. policies; directly impact tax revenue and govt. spending which can change level of fiscal debt, leading to a change in national debt level, e.g. lower corporation tax during a boom will reduce govt. revenue and increase the deficit and debt at a time when it would be naturally decreasing due to automatic stabilisers
13
Q
significance of the size of fiscal deficits and national debt
A
- interest rates; the higher the level of debt, the more concerned global lenders will be to continue lending to fund future deficits, so the UK may need ti raise IR ti entice lenders to lend as it increases the debt interest paid back to them
- debt servicing; the higher the debt, the greater the OC on repayments and interest repayments, e.g. the money spent on repayments could’ve been spent on education improvements instead
- rate of inflation; high inflation reduces purchasing power, but it allows the govt. to pay back lenders with money worth less than what it was when originally borrowed
- credit ratings; countries with a good credit rating will be able to borrow funds at a lower interest rate
- FDI; the higher the level of external debt, the more foreign currency is required by the govt. to repay it, but they may run short of foreign currency, so have to make FDI more attractive to obtain more of it, e.g. by selling assets to facilitate repayments
14
Q
use of macroeconomic policies
A
- fiscal policy; changes in public expenditure and taxation
- monetary policy; changes in interest rates and the money supply
- exchange rate policy; deliberate manipulation of the ER to influence competitiveness of a country’s goods and affect its level of economic activity
- supply-side policies; measures to increase efficiency, productivity and international competitiveness
- direct controls; govt. intervention to control prices or wages in an economy
15
Q
measures to reduce fiscal deficits and national debts
A
- reduce public expenditure
- increase taxes (austerity), but this causes hardships for many households and can increase inequality
- implement policies to increase economic growth which can reduce the fiscal deficit and national debt as a proportion of GDP
