4.5.3 Public Sector Finances

Question 1

What is a fiscal deficit?

Answer 1

When govt spending exceeds tax revenue

Question 2

What is national debt?

Answer 2

The cumulative total of past govt borrowing

Question 3

What is a cyclical fiscal deficit?

Answer 3

Occurs during recession since tax revenues decrease & govt expenditure (benefits) increase

Question 4

What is a structural fiscal deficit?

Answer 4

The deficit remains even when the economy is operating at its full potential (so more serious)

Question 5

What are some factors influencing size of fiscal deficit?

Answer 5

• economic cycle
• structural deficit
• the housing market
• political priorities
• discretionary fiscal policy

Question 6

How might the economic cycle influence size of a fiscal deficit?

Answer 6

• during a recession = an increase in budget deficit since
• tax revenues will be low due to fewer people workers = low income tax, lower consumer spending = lower VAT, firms make less profit = fall in corporation tax
• govt spending increase on unemployment and welfare benefits

Question 7

Factors influencing size of deficit (fiscal) (structural deficit)

Answer 7

• If the govt commit to investing in infrastructure, there will be higher borrowing
• e.g higher govt spending increased in the early 2000s contributing to an underlying structural budget deficit

Question 8

How might fiscal policy influence the size of a fiscal deficit?

Answer 8

Expansionary fiscal policy involves higher spending and lower taxes = increase size of budget deficit

Question 9

What is an expansionary fiscal policy?

Answer 9

This involves the government seeking to increase AD – through higher govt spending and/or lower tax.
- financed by increased government borrowing – and selling bonds to the private sector.

Question 10

What was Keynes’ view on expansionary fiscal policy?

Answer 10

• expansionary fiscal policy should be used during a recession – when there is unemployment, surplus saving and falling real output
• this injection of government spending = stimulate economic activity and get the unemployed resources back into productive use = economy to recover more quickly

Question 11

Effect of expansionary fiscal policy on graph

Answer 11

https://www.economicshelp.org/wp-content/uploads/2012/11/increase-ad-inflation-growth.jpg
- long run keynesian graph with an increase in AD

Question 12

What is a cyclical budget deficit?

Answer 12

This is caused by a contraction of GDP, especially a recession.
- It should automatically self-correct as the economy recovers and govt finances move to a budget surplus

Question 13

What is a structural budget deficit

Answer 13

Results from taxes being too low to pay for public expenditure.
- a budget deficit even when the economy is growing healthily and close to full employment
- it has to be remedied either by raising tax or reducing spending

Question 14

What are some factors influencing the size of national debts?

Answer 14

• the business cycle
• govt policy
• demographic changes

Question 15

What is the UK’s budget deficit like?

Answer 15

During the 1920s, UK ran a budget surplus.
- This was a period deflation, low growth and stagnant real wages
- Uk has not run a surplus for 40 years despite the pound increasing in value

Question 16

Factors influencing the size of national debts (the business cycle)

Answer 16

If an economy is in recession = a larger budget deficit

Question 17

How might govt policy influence the size of national debts?

Answer 17

• sometimes a govt might deliberately cut taxes or increase spending to boost growth (expansionary fiscal policy) = a bigger deficit if growth does not generate sufficient extra tax revenue

Question 18

Is high levels of borrowing/debt a problem?

Answer 18

• Other governments (such as the UK govt from 2010 to 2018) may regard high levels of borrowing and debt as a long term threat to the economy & seek to reduce the deficit through spending cuts (and/or tax increases). This has been called ‘austerity

Question 19

How might demographic change influence the size of national debts?

Answer 19

• Some countries are struggling with an ageing population & a smaller working population to pay for pensions
• this can be resolved by making choices between higher taxes, lower pensions or a later retirement age
• govts are reluctant to make these hard choices so that borrowing increases

Question 20

The significance of the size of fiscal deficits and national debts

Answer 20

• interest rates
• the rate of inflation
• debt servicing
• inter-generational equity
• the country’s credit rating
• FDI

Question 21

The significance of the size of fiscal deficits and national debts (interest rates)

Answer 21

• ceteris paribus
• higher borrowing = drive up interest rates as the govt is the largest borrower in the economy = crowding out = increase the costs for households in mortgage repayments and consumer credit

Question 22

The significance of the size of fiscal deficits and national debts (inflation)

Answer 22

• if the economy is close to full capacity, it is likely that higher govt borrowing may create excess demand = demand pull inflation

Question 23

The significance of the size of fiscal deficits and national debts (debt servicing)

Answer 23

• the more the govt borrows, the greater the national debt = the cost of interest payments on the debt
• sometimes this can lead to unsustainable and lead to the debt spiralling out of control since higher interest payments = more borrowing especially if the economy is not growing

Question 24

The significance of the size of fiscal deficits and national debts (debt servicing) example

Answer 24

A problem faced by Greece after the financial crisis, a stagnant economy and high borrowing lead to an ever increasing national debt

Question 25

Budget deficit

Answer 25

When the govt spends more than it receives in tax and other revenues it borrows to cover the difference

Question 26

UK budget deficit

Answer 26

In 2020/21, govt deficit was 318 billion pounds (high due to the pandemic)

Question 27

Why has the budget deficit increased during the pandemic?

Answer 27

1) the govt provided support
2) recession

Question 28

Why has the budget deficit increased during the pandemic? (Support to public services)

Answer 28

The govt provided support to public services, households and businesses (cost around 229 billion pounds) + public health concerns

Question 29

Why has the budget deficit increased during the pandemic? (Recession)

Answer 29

Whilst lockdown aimed to slow the virus, it took the economy to severe recession (less economic activity = smaller tax receipts = more govt spending e.g unemployment benefits)

Question 30

Govt revenue of UK

Answer 30

Govt revenue increased from 36.7% of GDP in 2019/20 to 37.1% in 2020/21.
- this is bc whilst govt revenue fell in cash terms, they became larger relative to the size of the economy ie the economy shrank more than revenues did

Question 31

Govt spending UK

Answer 31

Govt spending increased from 39.1% of GDP in 2019/20 to 51.9% in 2020/21

Question 32

How is the budget deficit met?

Answer 32

• is financed by sale of govt bonds (interest paying “IOUs” which the govt sells to investors). These make up most of govt debt
• purchasers of govt bonds include pension funds, insurance companies, households and overseas investors
• once the bonds have been brought, they can be traded by investors on secondary markets

Question 33

How the UK financed its budget deficit during the pandemic?

Answer 33

During the pandemic, the govt has sold record amounts of bond. The Bank of England bought large quantities of govt bonds from investors on the secondary markets.
- they did this to support the economy during the pandemic, through its quantitive easing programme

Question 34

What is the difference between a deficit and govt debt

Answer 34

• deficit: difference between govt revenue and spending, usually measured over a single financial year
• debt: the total amount owed by the govt which accumulated over the years

Question 35

Why might the govt want to reduce national debt?

Answer 35

• crowding out
• high levels of debt cost billions of extra pounds in interest payments

Question 36

How can national debet cause crowding out?

Answer 36

• “crowding out theory” which argues that increased government spending & borrowing = increases the supply of bonds, driving bond prices lower = higher interest rates in the market for loanable funds.
• If interest rates rise = contraction in planned capital investment by private sector businesses since borrowing costs have become more expensive = weaker investment = fall in AD
• Cutting the national debt = keep interest rates lower & help encourage consumption & investment from the private sector.

Question 37

Evaluation of national debt leading to crowding out

Answer 37

• Keynesian economists argue that state borrowing to fund infrastructure whilst adding to debt in the short run = improve trend growth = create extra tax revenues in the medium term.

Question 38

Reasons for the UK’s increase in debt

Answer 38

• much of the steep increase in debt from 2010-2016 happened bc of the bail-out of some banks & also a decision by the UK govt to allow the automatic stabilisers of fiscal policy to work during the post-crisis recession.
• Without that initial fiscal stimulus, alongside deep cuts in monetary policy interest rates, there was the real risk of a deflationary depression in the UK.

Question 39

Why might a country might want to avoid national debt?

Answer 39

• The country will have less to invest in its own future
• High and rising stock of national debt = risks leading to higher taxes in the future.
• Today’s borrowing debt could be tomorrows taxes. As this goes up, this can expense to service and potentially has a opportunity cost for the government