7. Fiscal Policies 2

Question 1

What is a Structural Deficit?

Answer 1

If the government felt that they wanted to grow the economy, even though the economy was pretty stable (i.e. not in a slump) they might finance this by borrowing.

Creating a deficit when the economy is sound (i.e. choosing deliberately to run a deficit) is called A STRUCTURAL DEFICIT

Question 2

What is a Cyclical Deficit?

Answer 2

In times of recession/slump governments are usually obliged to run a budget deficit.

1. Tax revenues are far lower than normal (less spending/fewer jobs so lower VAT/Income Tax)
2. Reasons for spending (e.g. benefits) are far higher than normal.

Question 3

How do Automatic Fiscal stabilisers work?

Answer 3

If the economy is growing, people will automatically pay more taxes ( VAT and Income tax) and the Government will spend less on unemployment benefits.

Question 4

What is a Debt?

Answer 4

Debt is a constant- if you have 20 years continuous deficits you build up a large debt.

Question 5

What is a Deficit?

Answer 5

A deficit is current- e.g. it is for 2014; how much the government will borrow this year.

Question 6

Who do the Government borrow money from?

Answer 6

1. UK pension funds / insurance companies (29%)
2. Private corporations / other financial institutions
3. UK Banks
4. UK Private investors

Question 7

What are the solutions to reducing the deficit size?

Answer 7

1. Increasing tax levels- very unpopular and difficult, not always effective either.
2. Austerity- cutting back on public spending- may lead to a recession.
3. Boost economic growth e.g. replacing current expenditure with capital expenditure.

Question 8

What is a Discretionary Fiscal policy?

Answer 8

Deliberate attempts to affect aggregate demand using changes in government spending, direct and indirect taxation and borrowing.

Question 9

What is a Expansionary Fiscal Policy?

Answer 9

This normally means raising levels of G:
e.g. Putting more money into schools/hospital roads

This should include increases in both current and capital expenditure.

Question 10

What are the problems with expansionary fiscal policy?

Answer 10

1. You are adding to the National Debt- borrowing has to be repaid
2. Time lags and Inflexible- may take too long to be effective- the wheels of government turn very slowly- can’t react quickly to changing circumstances
3. It depends on the multiplier effect but this is uncertain and unreliable

Question 11

What is Crowding out?

Answer 11

The crowding out effect is an economic theory stipulating that rises in public sector spending drive down or even eliminate private sector spending.

Question 12

How does crowding out work?

Answer 12

Resource Crowding Out:
The Bank of England (through DMO) sell bonds, gilts and other securities to the private sector. Therefore, the private sector lend their money to the government.

Financial Crowding Out:
To attract enough people to buy bonds, the government need to raise interest rates, to attract enough savers; this can put upward pressure on general interest rates.

Question 13

What is ‘Crowding in?’

Answer 13

This is when private investment increases as debt-financed government spending increases. This is caused by government spending boosting the demand for goods, which in turn increases private demand for new output sources, such as factories.

Question 14

What are Fiscal Rules?

Answer 14

Fiscal rules are attempts by the government to limit public sector debt and annual borrowing to certain criteria.

Question 15

What are the Fiscal Rules? (2)

Answer 15

2 common rules (applied by the EU) are:
1. Total Government debt must not be more than 60% of gross domestic product; (UK 86%)

2. The Government deficit must not be more than 3% of GDP except in particular circumstances.