4.5 Role of the state in the Macroeconomy Flashcards
what is public expenditure?
- represents a significant portion of AD
- the expenditure can be broken down into three categories
What are the 3 types of public expenditure?
- current expenditure
- capital expenditure
- transfer paymentsWhat area
What is Current expenditure?
- the daily payments required to run the government & public sector
What is a common example of current expenditure?
the wages and salaries of public employees
- such as teachers, police, military personnel etc
what is Capital expenditure
investments in infrastructure and capital equipment
What is a common example of capital expenditures?
- high speed rail projects
- new hospitals + schools
What are transfer payments?
payments made by the government for which no goods/services are exchanged for
- this type of government spending does not contribute to GDP as income is only transferred from one group of people to another
What are examples of transfer payments?
- unemployment benefits
- disability payments
- subsidies to producers and consumers
What are the major areas of expenditure
- pensions
- healthcare
- welfare
- education
- interest repayments
- defence
- protection
- transport
What are the main factors affecting the size and composition of public expenditure
- changing incomes
- changing age distributions
- changing expectations
- the global financial crisis of 2008
why does an increase incomes effect the size and composition of public expenditure?
LIC’s have low tax revenue leading to low government expenditure
-as incomes increase in an economy increase, government tax revenue increases allowing them to increase their expenditure
why does a decrease in incomes effect the size and composition of public expenditure?
- As incomes increase, citizens demand a higher quantity and quality of government services
-thus they are very income elastic
why do changing age distributions effect the size and composition of public expenditure?
ageing population and increased life expectancy cause government spending on pensions and healthcare to increase to support this elder population
why do changing expectations effect the size and composition of public expenditure?
pressure is put on government to change substance and delivery mechanisms of services to keep up with increased expectations
- results in increased spending through adjusting to technology advances
why did the global financial crisis of 2008 effect the size and composition of public expenditure?
- UK borrowing increased to facilitate the government spending required to avoid a long lasting depression
- the borrowing had to be repaid with interest, the government cut expenditure and raised taxes to facilitate this.
What is impacted by public expenditure?
- productivity and growth
- living standards
- crowding out
- level of taxation
- equality
How does public expenditure impact productivity and growth?
- some argue govt spending is wasteful and causes ineffiency
- alternatively they provide infrastructure such as roads
- education creates human capital necessary for growth
- through the spending the multiplier effect is created
how does public expenditure impact living standards?
- increase in g leads to increase in ad thus increase in real GDP; thus macro objective
- if increase in education healthcare etc, then increase in LRAS
How does public expenditure impact crowding out?
- government require funding for the increased expenditure
- this may come from government bonds
- the government increase interest rates to increase incentive for the bonds to be bough
- high interest rates cause a decrease in. borrowing for firms
- thus a decrease in capital investments.
how is the level of taxation impacted by public expenditure?
- if goc spending is high, levels pf tex must be high for spending to be sustainable.
- oil rich countries tend to be an exception as revenue from oil can pay for most government spending
How is Equality impacted by public expenditure?
spending should increase equality as it
- leads to redistribution
- provides a minimum standard of living
- ensures everyone has access to basic goods
What are the 3 tax system classifications?
- progressive,
- proportional
- regressive
What is a progressive tax system?
as incomes rises, a larger percentage of income paid is in tax
What is regressive tax system?
as incomes rise, a smaller percentage of income is paid in tax
- usually have a big impact on low- income households
What is proportional tax system?
the percentage of income paid in tax is constant, no matter what the level of income
What could economic tax changes impact?
- incentive to work
- tax revenues
- income distribution
- real output employment
- average price level
- the trade balance
- flows foreign direct investment (FDI)
What is the impact on the incentive to work by taxes?
- the higher the tax rate the lower the incentive for the unemployed to seek work
What is the laffer curve?
illustrates the relationship between increasing tax rates and the level of government revenues recieved
What is the impact on the tax revenues by taxes?
- as tax rates increases a point is reached where disincentivised workers work less resulting in less income and less government tax
What is the impact on the income distributionby taxes?
- a progressive tax system redisstrubtes from those with higher incomes to those with lower incomes + reduces income inequality
- however this does not give the poor anything so the system must be supported by benefits
What is the impact on real output and employment by taxes?
- cuts in taxation stimulate AD
- however imports may increase, link to MPZ or MPM
- this can increase real GDP if there is a spare capacity in the economy, ie a LRAS supply Is horizontal
What is the impact on the price level by taxes?
- an increase in indirect taxes reduces disposable income + workers may petition employers for a salary increase
- if they receive the increase the economy may face a wage-price spiral
- indirect taxes also increase costs of production for firms leading to cost push inflation
What is the impact on the trade balance by taxes?
- increase in taxes reduces disposable income which can reduce the level of imports
-this is dependent on the marginal propensity to import - improving the net trade balance
What does FDI stand and mean?
Foreign Direct Investments
- investment by foreign firms
What is the impact on FDI by taxes?
- Lowe taxes on profit and investment tend to encourage businesses too invest in a country since it will help them see a higher level of return
What is the public sector?
- central government
- local councils
- public corporations
- nationalised industries
what are public sector finances?
money in v money out
- borrowing
- debt
What is discretionary fiscal policy?
deliberate manipulation of government expenditure and taxes to influence the economy; expansionary and contractionary
- when the government chooses to change government spending and taxation
- a deliberate act/choice
What is expansionary discretionary fiscal policy?
- when fiscal policy is used deliberate;y to increase AD by increasing G or lowering taxation
- called a fiscal stimulus in the case of policies to help the economy recover from the financial crisis and Covid pandemic
What is contractionary discretionary fiscal policy?
when the fiscal policy is used to reduce AD buy reducing government spending /+ increasing taxation
- called austerity as the case of policies after stimulation to the economy for the recovery of covid pandemic (e.g.)
What are automatic stabilisers?
- occur naturally as G and taxation respond to changes in GDP levels
- act to stabilise movements from cyclical swings
how is a boom an eg of automatic stabilisers
in a boom progressive income tac structure takes a greater proportion of income tax, thus stabilising the boom
relationship between automatic stabilisers and the multiplier effect?
they reduce the size of the multiplier
- as an increase in withdrawals and leakages is likely to occur following an increase in income
What is another example of automatic stabilisers?
fiscal drag
What is fiscal drag?
- the government does not increase the personal allowanc/ taxes so more people are ‘dragged’ into paying income tax as wages increase taking incomes above the personal allowance
What is national debt
all accumulated budget deficits of a country
- can be expressed in absolute or as a percentage of GDP
What is fiscal deficit?
occurs when the level of government spending is greater than the government tax revenue in any given year
What is a structural budget deficit?
budget deficit that exists when removing the effects of the economic cycle on the budget deficity
- a deficit that occurs ignoring the effects of the economy
- occurs if the economy was operating at a sustainable level of growth and employment
What is a cyclical deficit?
- occurs due to downturns in the trade cycle, usually as a result of a recession
- gov receives less tax revenue as profits and income fall and G increases
- these deficits tend to self-correct as the economy starts to grow again.
What is the impact of a fiscal deficit?
- government spending increases, taxation decreases - expansionary f.p
- increase in g causes increase in AD thus
– inflation, employment, growth incresases
What influences the size of fiscal deficits?
- state of economy
- housing marekt
- policy priorities
- unforeseen events
How does state of economy influence the size of fiscal deficits
- gov rev increases in a boom or and decreases in recession
- gov spending decreases in a boom and increases in recession
- fiscal deficit increases as the state of the economy worsens
How does the housing market influence the size of fiscal deficits
gov receives an indirect tax from property sales (stamp duty)
- this rev increases when an economy is doing well and helps to reduce fiscal deficits
How does political priorities influence the size of fiscal deficits
- after gov spends more on rescuing an economy austerity is priorities with the focus of eliminating the deficit
what is austerity
contractionary gov policy that increases taxation and reduces gov spending to decrease deficit
How does unforeseen events influence the size of fiscal deficits
they require government support increasing government spending increasing the deficit
What are the factors influencing the size of national debts
- size of fiscal deficits
- gov policies
how does the size of fiscal deficit influence the size of national debts
- as an accumulation of annual fiscal deficits the size of fiscal deficit will grow by the size of the deficit
- if the uk ran a budget surplus the additional rev could pay some of the debt or used to fund gov spending or investments in the following year
How does government policies influence the size of national debts
these directly impact tax rev and gov spending, changing the level of fiscal deficit leading to change in national debt
what can size of deficits and national debts influence in an economy
- interest rates
- debt servicing
- inter-generational equity
- rate of inflation
- FDI
How are interest rates impacted by deficit and debts
the higher the level of gov debt as a proportion of GDP the more concerned global lenders will be to fund future deficits
- this may require uk to raise interest Raes to entice lenders to make their money available to the gov
How is debt services impacted by deficit and debts
- OC to paying back debt and debt interest
- higher the debt the greater the OC
How are Inter-generational equityimpacted by deficit and debts
todays borrowing has too be paid back from tax revenue received from future generations
- the greater the debt, the greater the burden on the next generation of tax payers
How are rates of inflation impacted by deficit and debts
reduced purchasing power allows gov to pay back lenders with money worth less than when it was originally borrowed
How are FDI impacted by fiscal deficit and national debts
higher the external debt the ore foreign currency is required by the gov to pay it
- countries may run short of foreign currency
- to obtain more is to make fid more attractive
- thus more assets are sold but more foreign currency used to facilitate repayments
