4.5.3 - public sector finances

Question 1

What are automatic stabilisers?

Answer 1

This refers to how tax rates and government spending automatically influence the rate of economic growth and help to counter swings in the economic cycle. eg. in a period of high growth, they help to reduce the growth rate as the government receives more tax revenue and spends less on unemployment benefits

Question 2

What is discretionary fiscal policy?

Answer 2

A deliberate effort/intervention by the government to influence AD and the rate of economic growth. It involves higher taxation and a cut in government spending.

Question 3

What is the difference between automatic stabilisers and discretionary fiscal policy?

Answer 3

Automatic stabilisers occur automatically to reduce fluctuations in the trade cycle, but discretionary fiscal policy is a deliberate policy from the government to achieve macroeconomic objectives.

Question 4

What is a fiscal deficit?

Answer 4

Annual difference between tax revenues and government spending - occurs when expenditure exceeds tax revenues, the amount the government needs to borrow in a particular year.

Question 5

What is the National Debt?

Answer 5

The total/cumulative amount of debt that the government owes the private sector. The accumulation of previous years’ borrowing.

Question 6

What is a structural deficit?

Answer 6

A fiscal/budget deficit that occurs even when cyclical factors are ignored , persists over the course of the economic cycle and is caused by inherent problems within the economy. The government needs to borrow even when the economy is operating at its full potential.

Question 7

What is a cyclical deficit?

Answer 7

During a recession, it is likely that there will be a rise in government borrowing due to cyclical factors. Lower growth leads to lower tax revenues as lower spending reduces VAT and lower incomes reduce income tax. Government spending increases in a recession as more is spent on income support and unemployment benefits. The government is likely to borrow when in a recession and pay this back during a boom.

Question 8

What are some factors influencing the size of a fiscal deficit?

Answer 8

-the state of the economy
-the housing market (which influences revenues from stamp duties)
-political priorities
-unplanned events

Question 9

How does the state of the economy affect the size of a fiscal deficit?

Answer 9

If the economy is in a recession, there will likely be a fiscal deficit due to low tax revenue and high levels of government spending. If an economy is in a boom period, there shouldn’t be a fiscal deficit as tax revenues would be higher and government spending at lower levels.

Question 10

How does the housing market influence the size of a fiscal deficit?

Answer 10

When more people own homes, there is a positive wealth effect causing increased consumption levels and a rise in AD. Real GDP levels would increase and economic growth would occur, leading to high tax revenues and low government spending - smaller fiscal deficit. However, is the housing market is in poor condition and home ownership levels are low, there will be a negative wealth effect and an economic downturn, causing a fiscal deficit.

Question 11

How do political problems influence the size of a fiscal deficit?

Answer 11

If there are political problems globally, the government may spend more in defence for example, increasing the size of the fiscal deficit.

Question 12

How do unplanned events influence the size of the fiscal deficit?

Answer 12

Events like COVID and Brexit reduce economic growth and lead to increase government spending and a fiscal deficit.

Question 13

What are some factors influencing the size of the National Debt?

Answer 13

-size of fiscal deficits
-government policies

Question 14

How does the size of fiscal deficits influence the size of the National Debt?

Answer 14

The larger the previous fiscal deficits were, the bigger the size of the accumulation of government borrowing from pervious years, therefore a larger National Debt.

Question 15

How do government policies influence the size of the National Debt?

Answer 15

If government decides to borrow excessively to fund investments, there is likely to be a larger National Debt.

Question 16

How do fiscal deficits and National Debt affect interest rate levels?

Answer 16

Government borrowing causes a rise in interest rates which may crowd out private sector spending and investment.

Question 17

What is crowding out?

Answer 17

As the government borrows to finance debt, they sell bonds to firms and individuals, this increases demand for loanable funds and increase interest rates, increasing the cost of borrowing and reducing private sector investment levels.

Question 18

How do fiscal deficits and National Debt affect debt servicing?

Answer 18

Government borrowing increases interest rates, causing debt servicing to become more expensive for the government, further adding to the National Debt. The 2025 forecast for the amount of interest to be paid on National Debt is £109 billion.

Question 19

How do fiscal deficits and National Debt affect the country’s credit rating?

Answer 19

A larger National Debt may reduce the credit rating of the government, leading to a higher interest rate on government borrowing in the future.

Question 20

How do fiscal deficits and National Debt affect FDI flows?

Answer 20

A structural deficit means the economy is facing structural problems, such as low labour productivity levels, increasing production costs. There will be poor returns on the capital employed eg. low output, poor quality, low TR and poor profit margins, so investing in the country is less attractive and FDI levels fall.

Question 21

How is an opportunity cost incurred on the debt servicing/interest paid on National Debt?

Answer 21

Governments are unable to spend on capital and current expenditure (opportunity cost), therefore the LRAS is shifted and there is a lack of spare capacity = could be inflationary. Reduced export competitiveness, increased import penetration leads to current account deficit. Depreciation of currency, cost posh inflation due to more expensive imports.