4.5 Role of the state in the macroeconomy Flashcards
What are the 3 categories of public expenditure?
Current expenditures
- spending by gov in short term on goods/ services
- all daily payments
- e.g wages to teachers etc, medicine to NHS
Capital expenditures
- investments on infrastructure and capital equipment
Transfer payments
- payments made from gov with no goods/ services exchanged
- e.g unemployment benefits, disability payments
What are the reasons for changing the size and composition of public expenditure?
Changing incomes
Demographic changes
Changing expectations
Global Financial Crisis 2008
What is crowding out?
Where extra gov spending leads to lower private sector spending
What is crowding in?
Where extra gov spending leads to more private sector spending
How do economists argue about the affect of public expenditure on productivity and growth?
Free market economists:
Wasteful and inefficient as they argue there is crowding out
Command economists:
Believe leads to vital growth
- e.g roads, education, NHS, benefit system, R&D
Also could lead to crowding in
What is the Laffer Curve?
As tax rates increase, work incentives decreases
Eventually, a higher tax rate actually decreases the total revenue of taxation
Creates a semi-circular curve
- y-axis = tax rev £
- x-axis = tax rate %
How do regressive tax rates effect income distribution?
Makes income less equally distributed
- as the higher income you get, the less tax rate they pay
How do progressive tax rates effect income distribution?
Makes income more equally distributed
- as the higher income you get, the higher tax rate they pay
How does level of tax rates effect real output and employment?
Higher taxes mean more money is withdrawn from circular flow of income (leakage)
Leads to AD decreasing, meaning less for workers to produce
Increasing unemployment and decreasing real output
Higher taxes means higher costs for firms, shifting SRAS upwards
Decreasing real output and increasing unemployment
How does level of tax rates effect the price level of the economy?
Increase in taxes may cause a wage-price spiral
- where employees ask for a pay rise as they are getting less income, leading to higher costs for firms, causing higher prices, causing inflation, causing even more protests for higher wages.
Indirect taxes can also lead to cost push inflation
How does level of tax rates effect FDI flows?
Higher corporation tax, less inward FDI, therefore possibly decreasing tax revenues if elastic
What are automatic/ built in stabilisers?
Automatic fiscal changes as the economy moves through stages of the trade-cycle
Usually expenditure automatically increasing in recession
Happen automatically in background
What is a discretionary/ active fiscal policy?
Demand-side policy that uses gov spending and taxation policy to influence AD
Deliberate manipulation of gov expenditure and taxes to manipulate economy
What is national debt?
The accumulation of all previous fiscal deficits
Deficits add to national debt
What are the 2 types of fiscal deficit?
Cyclical deficit
Structural deficit
What’s cyclical deficit?
Deficit that occurs during recession that is expected
When gov receives less tax revenue and gov spending may increase
Tends to self correct when economy grows again
What’s structural deficit?
Present even when economy is operating at full employment
A real deficit
Caused by tax avoidance culture or for governance
Uk struggle with this due to high public spending, slow growth, tax burden, 2008 overhang, interest etc
What’s primary deficit?
Deficit that doesn’t include interest
What factors influence the size of the fiscal deficit?
State of economy
Housing market
Debt interest
Political priorities
Unforeseen events
What factors influence the size of national debts?
Size of fiscal deficit
Gov policies
How can the size of deficit and national debt effect interest rates?
The bigger proportion of debt of GDP, Govs have to borrow more as they cant cover their expenses
Govs compete with firms and consumers for loans
Higher demand for loans mean investors demand higher interest rates (yields) on gov bonds
Therefore increasing interest rates of economy
However, may not raise interest rates as:
- Gov may borrow abroad
- In a recession, private sector borrowing will fall
- quantitive easing used to borrow more at virtually zero interest
What is inter-generational equity?
Fair distribution of resources across various generations
How does the size of national debt effect inter-generational equity?
The higher debt, the more needed to pay back due to interest in the future
Leads to less inter-generational equity
How do inflation rates effect size of deficit and national debt?
Higher inflation allow Govs to pay back got less as it reduces value of debt
However, reduces purchasing power, making it more expensive to borrow abroad if exchange rates change
How can the size of deficit and national debt effect FDI?
Countries with high external debt (borrowing from abroad) require the gov to pay it back in that foreign currency
- Countries short of it obtain foreign currency from FDI, making FDI more attractive to that country
However, high debt is unattractive to FDI
What is demand management?
Fiscal policies used to manipulate level of AD
Expansionary and deflationary fiscal policies
What policy measures are used to reduce fiscal deficits and national debts (unsustainable debt)?
Quantitive easing (QE)
Fiscal austerity
How can Quantitive easing (QE)
Central bank buys gov bonds from private sector, increasing demand whilst supplying money into economy
Leads to motor money for banks to lend, lowering interest rates
Reduces cost of borrowing for gov and encourages spending and investment, stimulating growth
Leads to more tax rev
Also increases inflation to decrease real value of debt
What is fiscal austerity?
Increasing taxes or cutting gov spending to reduce gov deficit
What policy measures are used to reduce poverty and inequality?
Progressive tax system
Free healthcare and education
What policy measures are used to increase international competitiveness?
Protectionism
Currency depreciation
Supply side policies
What policies combat commodity price shocks?
Attempt to counter the inflation from the caused shift upwards in SRAS by a deflationary fiscal/ monetary policy
Buffer stock schemes
What polices combat a major financial crisis?
Expansionary monetary policies were used in 2008, cutting interest rates to basically zero, but still didn’t work
So used quantitive easing with trillions of pounds
What is a transnational company?
A company operating in 2 or more countries
Same as MNC
What are the factors limiting a country to control global companies?
Power of gov in relation to MNC
Level of corruption
State of development of financial, legal, media institutions
What is transfer pricing?
Resources being transferred at a low transfer prices between branches of an MNC
Leads to overall lower tax for that country
Unfair as its tax avoidance, undermining local economy, and lack of transparency
Govs try to stop transfer pricing
How else can Govs stop power of transnational companies?
More rigorous labour protection laws, by making firms use their country’s labour
Establishing more rigorous laws around technology transfer between local and transnational firms
Establishing limitations on level of exports by these transnational firms
What is direct control?
A gov measure that is imposed on the price/ quantity of a single product or factor of production
What problems face policymakers?
Inaccurate information
Risks and uncertainties
Inability to control external shocks
