4.5. Role of the State in the Macroeconomy Flashcards
What is the primary reason for government spending?
To control AD and achieve macroeconomic objectives such as economic growth, low inflation, balanced current account, and low unemployment
Government spending also aims for equity and equality by providing services to underprivileged groups and correcting market failures.
What are the three main types of government expenditure?
- Capital government expenditure
- General government final consumption
- Transfer payments
What does capital government expenditure include?
Spending on investment goods such as new roads, schools, and hospitals
These are typically consumed over a year.
What is general government final consumption?
Spending on goods and services that will be consumed within the next year, such as public-sector salaries
What are transfer payments?
Government payments for which there is no corresponding output, such as benefits and pensions
What percentage of government spending is allocated to pensions?
20%
How does the average income of a country influence government expenditure as a percentage of GDP?
Lower average income usually leads to a lower percentage of GDP spent by the government due to lower tax revenue
What was one major effect of the Global Financial Crisis on government spending?
Huge increases in government spending due to increased welfare payments and bank bailouts
What is the impact of an aging population on government spending in Europe and Japan?
Increased pressure on government spending due to larger pension bills and higher levels of care needed
How can government spending improve productivity and growth?
- Provides necessary infrastructure
- Develops human capital through education
- Reduces illness through healthcare
- Supports research and development
What is the crowding out effect?
When government borrowing competes with the private sector for finance, leading to higher interest rates and reduced private investment
True or False: Transfer payments cause crowding out.
False
Transfer payments do not take resources from the economy; they merely redistribute money.
What is a progressive tax?
A tax where higher income earners pay a higher percentage of their income in tax
What is a regressive tax?
A tax where the proportion of income paid in tax falls as the income of the taxpayer rises
What is the Laffer curve?
A theory that shows that increasing tax rates does not necessarily lead to increased tax revenue
What is the difference between structural and cyclical deficits?
- Cyclical deficit occurs due to fluctuations in the trade cycle
- Structural deficit exists when the economy is at full employment
What happens to the fiscal deficit during a recession?
Tax revenues decrease and government spending increases, leading to a larger deficit
What role do automatic stabilisers play in the economy?
They reduce the impact of economic changes on national income, such as increasing benefits during a recession
What is discretionary fiscal policy?
The deliberate manipulation of government expenditure and taxes to influence the economy
What is the main purpose of taxation?
To pay for goods and services provided by the government and to correct market failure
Fill in the blank: A ______ tax system increases income equality by taking more from the rich than the poor.
progressive
What is the impact of high marginal tax rates on work incentives?
They may discourage individuals from working
What is a potential negative effect of high levels of taxation?
They can lead to a disincentive to work hard
True or False: High VAT has a greater disincentive effect than high income tax.
False
Income tax is considered more disincentive than VAT.
What can high corporation taxes lead to in terms of income distribution?
They take money from wealthier shareholders and redistribute it through government spending
What impact do indirect taxes have on inflation?
They often cause cost-push inflation
What is the relationship between tax changes and trade balance?
A rise in taxes can decrease income and consumption, potentially improving the trade balance in the short run
What is the risk of low taxes on profit and investment?
It can lead to a ‘race to the bottom’ among countries, reducing overall tax revenues
What is a structural deficit?
A situation where the government consistently borrows money to finance spending, leading to a likely growth in national debt over time.
Structural deficits are challenging to identify as they contain both structural and cyclical components.
What factor significantly influences the size of fiscal deficits during economic downturns?
The trade cycle, where tax revenue decreases and government spending increases, leading to a larger deficit.
In the UK, the fiscal deficit peaked at 10.1% of GDP in 2010.
What role do interest rates play in government fiscal deficits?
Higher interest rates on government debt increase the amount paid in interest repayments, likely increasing the deficit.
7% of all UK government spending is on interest repayments.
How can events like privatisation affect the fiscal deficit?
Privatisation can provide one-off payments to the government, decreasing the deficit in the short term.
The impact depends on the value of the company sold.
What is the relationship between fiscal deficits and national debt?
Continuous fiscal deficits lead to an increase in national debt, especially if deficits exceed 3% of GDP.
A budget surplus is required for the national debt to decrease.
How does an ageing population affect national debt?
It contributes to high national debt due to structural deficits needed to fund pensions and care.
This leads to increased government borrowing.
What is a primary budget deficit?
The actual budget deficit excluding interest repayments on national debt.
The impact of primary deficits depends on interest rates and their size relative to interest repayments.
True or False: High fiscal deficits can cause inflation.
True.
Increased government spending without a decrease in private sector spending can lead to inflation.
What happens if a government prints more money to cover deficits?
It can lead to hyperinflation, depending on the amount printed and the economy’s position on the LRAS.
Historical examples include Germany in 1923 and Zimbabwe in 2008.
What is the impact of high national debt on a government’s credit rating?
It tends to result in a reduced credit rating, leading to higher interest rates demanded from lenders.
Credit ratings range from AAA to D based on default risk.
What is one potential benefit of government borrowing for capital spending?
It can stimulate growth by improving the supply side of the economy, potentially reducing the deficit in the long term.
Keynesians support using deficits as a stimulus during recessions.
What policy has the UK government implemented since 2010 to reduce national debt?
Austerity measures aimed at decreasing spending.
This approach is often unpopular and can limit growth.
What is one method to redistribute income and reduce inequality?
Implementing a progressive tax system that taxes higher incomes at higher rates.
Inheritance taxes can also help reduce wealth inequality.
What are means-tested benefits?
Benefits available only to individuals with low income or wealth, targeted to provide support where it is most needed.
They are effective in improving inequality.
What is the effect of a national minimum wage on income inequality?
It can improve the incomes of the poor but may lead to unemployment.
Maximum wages or pay ratios can also reduce the incomes of the rich.
What is the law of diminishing marginal utility in relation to income redistribution?
It suggests that redistribution increases total utility, as the poor gain more satisfaction from additional income than the rich.
This supports the argument for redistributing income.
How do central banks influence interest rates and money supply?
They can change interest rates to control inflation and manage economic stability.
Changes in bank rates affect the demand for loans.
What does quantitative easing aim to address?
It aims to combat deflation when interest rates are already low and cannot be further reduced.
Used by central banks like the Bank of England post-financial crisis.
What are supply-side policies aimed at improving?
They aim to enhance productivity and competitiveness in the economy.
Includes measures like tax incentives and deregulation.
What are automatic stabilisers in relation to national debt?
Economic mechanisms that help stabilize the economy and reduce the deficit as GDP grows, without direct government intervention.
The US used this approach after the Global Financial Crisis.
What is the role of exchange rate policies in government economic strategy?
They can be used to control inflation and ensure macroeconomic stability.
For example, China may devalue its currency to make exports cheaper.
What is the impact of globalisation on national economies?
It increases interdependence, making economies more susceptible to external shocks.
Governments need to adapt policies to mitigate these effects.
What is one potential consequence of implementing price controls on essential goods?
It can lead to excess supply and the development of black markets.
Price controls aim to increase the spending power of the poor.
What was the initial action taken regarding rates to improve confidence?
Rates were lowered.
Why were rates raised after being lowered?
To deal with inflation caused by the falling value of the pound.
How much has the chancellor set aside to deal with the effects of Brexit?
Around £3bn.
What is the estimated amount to be spent in order to leave the EU?
Around £35bn.
What can changes in exchange rates cause?
Inflation or a fall in growth and a poor balance of payments.
What is one potential impact of political instability on the economy?
It may require government action.
What are the positive impacts of Transnational Companies (TNCs)?
- Creation of jobs
- Tax revenue
- Knowledge transfer
- Investment
What are some negative impacts of TNCs?
- Destroying local culture
- Affecting the environment
- Withdrawing more in profits than they inject
- Influencing politicians for favorable decisions
- Involvement in tax avoidance
Is it legal for TNCs in the EU and USA to use bribery or corrupt practices?
No, it is illegal.
What requirement do some developing countries impose on TNCs?
To set up a joint company with a local partner.
What is transfer pricing?
A method for firms to engage in tax avoidance by manipulating prices between subsidiaries in different countries.
What is the aim of companies using transfer pricing?
To increase profits in low tax countries and decrease them in high tax countries.
What has HMRC done regarding companies that don’t allocate sufficient profits in the UK?
They challenge these companies, leading to billions in tax collection.
What principle do the OECD Transfer Pricing Guidelines aim for?
The ‘arm’s length’ principle.
What is a challenge for governments in controlling TNCs?
Small countries may earn less revenue than TNC profits.
What are two examples of legal tax avoidance schemes in the EU?
- Dutch sandwich
- Double Irish
What is the proposed tax loss ratio for other countries compared to Luxembourg?
For every £1 gained in extra taxes by Luxembourg, other countries lose possibly £1000.
What is a major difficulty in finding solutions for taxation issues?
It requires worldwide agreement.
What type of information can be inaccurate for policymakers?
Short-term information like GDP figures.
What is a risk for the government when trying to predict economic needs?
The inability to accurately predict the future.
What are external shocks?
Events that the government cannot control or prepare for.
What has Brexit delayed regarding government plans?
Plans to balance the budget.
