4.5 Role of the State in the Macroeconomy Flashcards
What are the main types of expenditure
- Capital Expenditure
- Current Expenditure
- Transfer Payments
What is capital expenditure
This is government spending that increases the capital stock of the economy (Increasing LRAS)
What is current expenditure
This is government spending on items that are recurring and only lasts a limited time e.g. spending on public sector wages
What are transfer payments
payments from the government to individuals, represents a redistribution of income in society
e.g. pensions, welfare payments
What are the 2 key measures of government spending
- Real government spending – Spending levels adjusted for inflation.
-
Government spending as a % of GDP – Government spending, as a
share of national income.
How has UK public spending as a % of GDP changed over time
Government spending as a % of GDP rose sharply from 2000 to 2022, with a
peak in 2020/21 due to the Covid Pandemic.
How has UK public sector reciepts changed as % of GDP
government spending also correlates to UK public sector receipts (mostly tax revenue). There was a prolonged fall in tax revenues as a % of GDP from 1981 to 1993, which has since been reversed.
What is the impact of higher government spending
- More investment in education and infastructure
- Redistribution
- Fiscal Policy - in rrecession can be effective to stimulate economy
- Crowding in
Evaluate the effects of higher government spending
- Higher taxes create disincentives for work/investment
- Public Sector lacks efficiency from no profit motive
- Crowding out resources from the private sector
- Vested interests push governments to inefficiency e.g. lobbying
- Kind of Spending- welfare payments may be detrimental to efficiency
- Spending doesn’t have to be inefficient if it utilises the private sector
What is UK government spending in 2023 by size
- Healthcare (20%)
- Pensions (17%)
- Welfare (13%)
- Education (10%)
- Interest (8%)
- Defence (6%)
- Transport (4%)
What influences the size and composition of public spending
- Incomes
- Demographics
- Expectations - esp in democracy
- Business Cycle
- Interest on debt
- Inflation- raise MNW, UE Benefits, Pensions
- Political Priorities -political churn, election
- State of Global Economy
How does the stage of development influence public expenditure
- Developing: low tax revenue due to avoidance, inefficiency and little wealth to tax–> Can’t provide much through spending
- Developed: demand more services frrom governments ( income elastic )
How did the 2008 Global Financial Crisis influence public expenditure
- Huge increases for welfare payments + Bailouts
- but induced 2010 austerity to rweduce debt
How will ageing populations affect public expenditure
Europe and Japan will see pressure on government spending due to aging populations meaning larger pension bills and higher levels of care
needed.
What is the effect of public expenditure on productivity and growth
- infrastructure reduces costs for businesses
- Education increases human capital –> increased productivity
- Healthcare reduces the number of days sick
- Crowding in on frontier
- Free Market argues gov. spending is wasteful
What is the government multiplier of spending according to the OECDs
Gov. fiscal multiplier of 1.5-8 according to IMF
What is the effect of government spending on living standards
- Improve social welfare (correcting mkt failure + providing public goods)
- Reduce absolute poverty through benefits + Healthcare
but needs funding by higher tax - debt so crowding out
Evaluate the effect of government spending on living standards
government will be inefficient at providing goods and services and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall.
government principal agent problem since they make decisions on behalf of the people who may have spent that money differently. As a result, there is a loss in welfare and so a fall in living standards.
What is crowding out
a process where an increase in government spending
leads to a fall in private sector spending.
What is financial crowding out
If the government increases it’s spending – say through selling bonds – The demand for money will increase, which, ceteris paribus, raises interest rates.
At higher interest rates, both consumer spending and investment spending are likely to fall.
The aggregate effect on the economy is that financial resources are diverted from private firms to be used by the public sector.
How does financial crowding out lead to a fall in GDP
Initially, via a multiplier effect, national income increases, but as a result of the government selling securities in the financial markets, the demand for scarce loanable funds increases.
This drives up interest rates, which causes a contraction in the demand by the
private sector for investment goods (capital) as well as reducing the demand for
consumer goods. This, in turn, leads to a fall in GDP.
What is crowding out in relation to the labour market
a relative increase in the public sector may push up wages in order to attract workers from the private sector.
The increased demand for labour reduces unemployment and ‘tightens’ the labour market, leading to possible shortages of labour available for the private sector use as well causing upward pressure on wage levels across the economy.
What fundamental financial fact drives crowding out
that financial and real resources are ultimately scarce, and if one sector of the economy increases its use of these resources, fewer are available for use in other sectors.
What is the Ricardian Equivalence
This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes.
The theory argues that people will save based on their expectation of
increased future taxes to be levied in order to pay off the debt, and that this will offset the increase in aggregate demand from the increased government spending.