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Macro > 4.9 role of the state in the macroeconomy > Flashcards

4.9 role of the state in the macroeconomy Flashcards

1
Q

What are the global economic objectives?

A
  • Economic growth - GDP per capita - GNI/Population
  • Environmentally sustainable growh
  • Low and stable inflation
  • Equilibrium in balance of payments
  • Poverty reduction/redistribution of incomes
  • Fiscal balance - tax revenue = government spending
  • Full employment - low unemployment rates
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2
Q

What is the government expenditure in the UK?

A
  • 2% on defence
  • £800bn in 2019-19
  • 0.7% on aid
  • Increase state pension
  • £146bn on health and £89bn on education
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3
Q

What are the 3 types of government spending?

A

-Current - day to day e.g. wages of doctors, drugs in healthcares, books, road maintenance, arms

Capital: one off investments - hopsitals, schools, equipment, defences

Transfer payments: not in exchange for goods, labour or rent. Often used to redistribute incomes e.g. pensions, JSA, tax credit

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4
Q

What is the significance of governent spending?

A
  • component of AD
  • Regional economic impact
  • Provides public and merit goods
  • Greater equality
  • Child/unemployment benefits
  • Pensions
  • WEflare payments
  • Education
  • Healthcare
  • Soial Housing
  • Employment trading
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5
Q

What factors affect government spending?

A
  • GDP
  • Demand for public spending
  • Demographics
  • Business cycle
  • Inflation
  • Debt interest
  • Discretionary fiscal policy
  • Political factors
  • Available wealth
  • Institutions, infrastructure and history
  • Demographics
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6
Q

What are the justifications for government spending

A
  • Public goods tend to be under provided
  • Improved public services improve human capital, productivity and gains to society - up msc
  • Safety net system of welfare benefits to poorest and redistribute income and wealth
  • Provide infrastructure
  • Meet macroeconomic policy objectives
  • Promote equality
  • Efficiency and competitiveness improved
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7
Q

What is crowding out - how is it illustrated?

A
  • When government spends money it leads to a transfer of scarce resources from the private sector to the public sector where productivity may be lower
  • This leads to higher taxes and interest rates which squeezes profits, investment and employment in the private sector

It can be illustrated using interest rates against quantity of loan able funds. With higher government borrowing the demand for loanable funds rise, thus pushing out the demand curve and pushing up the rice

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8
Q

What is some evaluation of crowding out theory?

A
  • 100% crowding out almost impossible especially if an economy is operating below capacity so there is excess supply of saving available to purchase new state debt instead of borrowing
  • Fiscal deficits may actually crowd in private sector demand and investment
  • Well targeted increases in spending absorb under utilized capacit and provide multiplier effect
  • Supply of loanable funds is not limited to domestic sources
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9
Q

What is crowding in?

A

Increase in government spending leads to expansion of economic activity incentivizing private sector firms to raise investment and employment.

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10
Q

What are the impacts of cuts in government spending?

A
  • Output, jobs and profits in construction and defence fall
  • Effects on real income and poverty
  • Effective demand for goods and services change
  • Multiplier effects of cuts in public sector spending
  • Helps investor confidence and investment
  • Risk of deflationary spending if creates excess capacity
  • more likely to keep interest at low levels
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11
Q

What are the types of tax?

A

Direct: income, wealth and profit e.g. income, national insurance, capital gains, corporation tax - burden not passed on

Indirect: on spending - duties on fuel, cigarettes and alcohol and VAT e.g. sugar tax - may be passed on

Progressive tax: marginal rate of tax rises as incomes rise - as you earn more you are taxed more, increasing the average rate of tax

Proportional: proportion of tax same throughout bracket

Regressive: proportion of income paid falls as incomes rise e.g. duties on tobacco and alcohol - this is because lower income earners pay a higher proportion or percentage of their incomes than high income earners.

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12
Q

What are the objectives of taxation?

A
  • Fiscal policy
  • Influence consumer choice
  • Internalize negative external costs
  • Fund public spending - defence and security
  • Redistribute income and reduce inequality.
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13
Q

What are the progressive tax rates in the UK?

A
  • 0 tax up to 12,500
  • 20% 12501-50,000
  • 40% 50,001 - 150000
  • 45% above 150k
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14
Q

What are Smith’s ‘canons of taxation’

A
  • Cost effective - cost of collecting lower than yield of the tax
  • Clarity - how much and when to pay should be clear for taxpayers
  • Convenience - how and when the tax is paid must be convenient
  • Fair - levied according to ability to pay
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15
Q

What is fiscal drag?

A

-nominal pay rise to maintain rael value of wages takes workers into higher tax brackets so increases tax revenue in real terms

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16
Q

What is the laffer curve?

A

-Shows relationship between economic activity and tax rates, suggesting there is an optimum tax rate maximising tax revenues

It starts to fall because:

  • Increased tax avoidance
  • Incentive to evade trades
  • Disincentivises labour market
  • Brain drain effect - firms and people move out

It is a n shaped curve

17
Q

What is some evaluation of the laffer curve?

A
  • Lower top rate taxes may increase income inequality
  • Little evidence high top rates of income tax is a barrier to inward migration as many are on lower income
  • Many on fixed contracts
  • Tax cuts make them take more leisure time instead of work if taxes are cut
  • Other impacts such as direct and indirect taxes increasing real disposable income leading to higher consumer spending and AD
18
Q

How do taxes influence AD and AS?

A

AD:

  • TAx allowances have effect on growth
  • reduce real disposable incomes
  • affect post tax profits for businesses
  • changes cost of employing workers in labour market
  • Changes retail prices and real incomes

AS:

  • SRAS and LRAS impact
  • Businesss costs rise with VAT
  • Changes in direct tax influence work incentive
  • Business tax may affect FDI
  • Affect confidence and incentive to start a business or spend on R&D.

Evaluation:

  • Impact depends on scale of tax/tax cut
  • Other factors affect investment e.g. technological advancements
  • Some investment may lead to labour replacement e.g. robotics
19
Q

What are automatic stabilisers?

A

-Changes in tax revenue and government spending that come about automatically as the economy moves through the business cycle

In a downturn, GDP growth slows, more employment benefits are paid out so AD is raised, partly countering the fall in growth

In an upturn, GDP rises but so will inflation, Wages will also rise, leading to workers losing real incomes to tax, counterbalancing the rise in spending

Tax: when economy expanding, tax revenue increases taking money out of the circular flow of income and spending

Welfare: growing economy means the government does not have to spend as much on means-tested welfare benefits such as income support and unemployment benefits

Budget balance: fast growing economy leads to outflow of money and slowdown government ends up spending more and revenue is lower

20
Q

What is government borrowing?

A

The state borrows in the form of bonds. The yield on a bond is the interest rate paid on state borrowing. Purchasers of bonds may include pension funds, insurance and overseas investors.

Public sector net borrowing is the amount the government must borrow each year to fund their spending.

The public sector net cash requirement is the difference between the governments incomes from taxation and cash required to run public bodies.

As such, the PSNB is the PSNCR - any amount the government may fund in other ways that borrowing e.g. selling assets won’t change PSNCR but reduce the PSNB

21
Q

What is national debt?

A

-Debt is a measure of the accumulated national debt owed by the state sector.

Public sector debt is owed by central and local governments as well as state owned corporations.

22
Q

How does the size of a deficit change in the business cycle?

A
  • Boom - GDP expanding, above potential - tax receipts high and spending on benefits low so reduces borrowing
  • Recession - borrowing high, rising unemployment and falling real incomes.

A structural deficit is not related to the state of the economy and so will not disappear once recovered from a recession.

23
Q

What factors influence the size of deficits?

A
  • Unemployment
  • Consumer spending - increases VAT revenue
  • Business profits
  • Automatic stabilisers

Long run factors:

  • Size of welfare state
  • Relative level of benefits to incomes
  • Demographic factors
  • Size of tax base and tax rates
  • Efficiency of the public sector
24
Q

What factors influence the size of debt?

A
  • Current spending on public services
  • Investment spending
  • Spending on welfare
  • Size of tax base
  • Efficiency of tax collection
  • Yield on new and existing government bond (debts)
  • Willingness of lenders to give the government new credit
  • Government bailouts of businesses add to debt.
25
Q

What is the UK debt forecast?

A
  • £.184tn or 86% of national income

- Due ot financial crisis and second world war.

26
Q

What are the problems of national debt?

A
  • Rising debt interest
  • Interest opportunity cost
  • Free up spending on health and education
  • Increase in national debt cause high tax for future
  • Crowding out of private sector investment as government spending increases
  • Structural deficits - gets worse as ageing populations raise spending on pensions, health and social care
  • Impact on exchange rates as less lend, debt rises is value, currency weakens
  • Potential need to raise interest to attract lenders who are reluctant to lend
27
Q

Why may debt be beneficial?

A
  • Borrowing may not cause crowding out as private sector cuts back in recession anyway
  • Increased spending enabled by borrowing maintains AD in a downturn when consumption and investment is falling
  • When interest rates are low the state may borrow at low rates as people buy bonds
  • Supply side investment such as infrastructure may see benefits in the future
  • Automatic stabiliser of budget deficit to cushion fall in AD caused by economic shock - deficit is needed to lift AD back up
  • If interest rates are low it makes sense for the government to borrow money to aid infrastructure and competitiveness.
28
Q

What are bond yields and how do they finance debt?

A

-Government bonds are fixed securities so it pays a fixed annual interest known as the coupon.
The yield is effectively the interest on a bond which will vary with the market price of a bond.

When bond prices are rising, the yield falls
When bond prices falling, the yield will rise.

e.g. $5,000 bond, paying fixed coupon of $200 so yield is 4%

If bond falls to $4,300 then yield is 4.65%

If bond rises then yield is lower

29
Q

What is fiscal austerity?

A
  • Cuts in government spending to reduce fiscal deficit and control/lower the size of debt.
  • Put in place in UK after GFC
30
Q

What policies are put in place to reduce fiscal deficits?

A

Cuts in government spending:

  • Control public sector wages
  • Limit welfare
  • Privatise state assets
  • Reduce subsidies

Taxes:

  • higher indirect taxes - VAT rise to 20%
  • cutting tax allowances or tax reliefs
  • Bringing in new taxes

Supply side policies:

  • Growth and competitiveness
  • Stronger GDP growth increases revenues because the tax base widens and businesses are earning higher incomes and profits
  • Progressive tax systems expanding incomes and prices lead to faster growth of tax receipt
  • Growth cuts a deficit as a percentage of GDP as the denominator has increased
31
Q

What is the UK’s current strategy?

A
  • Cutting budget deficit to below 2% of GDP
  • Public sector debt:GDP ratio falling
  • Keep total welfare spending below a cap.
32
Q

What are the arguments for and against austerity?

A

For:

  • Keeps taxes lower, less crowding out, good for growth
  • Encourages private sector growth as less public
  • High opportunity cost of over £50bn spent each year on debt interest
  • Improves investor confidence
  • Upturns mean should borrow less - this is ahead of a downturn and so makes sense to run stronger finances before the economy is a downturn

Against:

  • Self defeating - price deflation and unemployment s depressses investment
  • Yields on bonds are low so less to invest
  • Economic growth neede to pay back debt, austerity makes harder to achieve
  • Increased inequalities and poverty
  • Pay freezes harm recruitment and lead to shortages
33
Q

What policies are put in place to reduce inequalities?

A
  • Welfare - cash to poorer households, pension systems, subsidize occupational mobility and transport and child care
  • Labour market: legal protection, NMW, universal basic income, improve training and producitivty

Tax reforms:
-Progressive taxes and taxing profits of businesses to fund state spending.

34
Q

What policies are put in place to improve competitiveness?

A
  • Labour market:
  • Investment in education and training
  • Inward migration
  • Improvements in management quality
  • Infrastructure:
  • Transport systems
  • Sewage
  • Clean energy networks
  • Communications

Enterprise:

  • Business finance improved
  • Incentives for innovation
  • Reduce red tape

Stability:

  • Low inflation and price stability
  • Sustainable banking system to imrpove flow of finance
  • Competitive exchange rate versus major trading partners
35
Q

What are external shocks?

A
  • Economic recessions of trading partners
  • Unexpected tax increases or austerity programmes
  • Financial crisis - credit falling and lending falling
  • Changes in interest rates
  • Job losses in industries
  • Oil/resource prices
  • Political turmoil
  • Natural disaster
  • Technological breakthroughs
  • Migration level changes
36
Q

What policies are put in place to absorb a shock?

A
  • Floating exchange rates
  • Freedom to adjust monetary policy - QE and interest
  • Geographical and occupational mobility
  • Non price competitiveness
  • Diversify economy - not reliant on few sectors
  • Strong fiscal position - stabilisation funds and finances
37
Q

What measures are put in place to combat TNCS?

A

Tax avoidance e.g. Apple setting up in Ireland with 12% corporation tax.
-4-10% of global tax revenues are lost to tax avoidance. Many countries have lowered corporation taxes to attract FDi

Reforms:

  • Introduce minimum tad rate
  • Favour new digital service taxes specifically for Amazon and Apple
38
Q

What is transfer pricing and what are the benefits and costs of hosting TNCs?

A

Transfer pricing is when TNCs move profits they have made from subsidiaries in high tax countries to subsidiaries in low tax nations.

Benefits:

  • Employment and training
  • Skills and expertise
  • TNCs add to GDP with spending
  • Competition incentivises growth and efficiency
  • Extends consumer and business choice
  • Profitable TNCs source tax revenues

Costs:

  • Domestic businesses may not be able to compete
  • TNCs abuse lower regulations - immoral
  • Impose cultures on host country - westernisation
  • Profits remitted back to base country
  • Make use of transfer pricing and tax avoidance measures to reduce profits on whcih they pay tax to the government.

Macro (24 decks)

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