Budget, Fiscal policy MM Flashcards
What are the 3 main types of policy?
1) Fiscal policy
2) Monetary policy
3) Supply-side policies
What is fiscal policy concerned with?
Direct government intervention- influencing AD with G&T
What is monetary policy?
A form of indirect intervention- carried out by the central bank, not gvnmt- uses interest rates or QE to influence AD
What affect will higher G or lower T have on AD?
Increase AD
What affect will lower G or higher T have on AD?
Reduce AD
What affect does a
decrease in interest rates have on AD?
Increase AD due to lower cost of borrowing
What are supply-side policies?
Created by gvnmt in order to influence AS
How could supply side policies increase AS?
Policies decrease costs of production
What is a budget?
A financial plan/outline of expected spending and expected revenue for the next financial period
What are the 2 types of taxes?
1) Indirect taxes
2) Direct taxes
What are indirect taxes?
Taxes on goods and services (e.g. sugar tax)
What are direct taxes?
Taxes on income- specifically to the individual or business
What are the 3 approaches to taxation?
1) Progressive
2) Proportional
3) Regressive
What is proportional taxation?
Everybody pays the same % of their income in tax
What is regressive taxation?
When higher income groups pay a lower % of their income in tax- hits poorer groups the hardest
What is progressive taxation?
Ensures higher earner pay a higher % of their income
What is the marginal rate of tax?
The rate of taxation we pay on the last £ we earn
What are regressive taxes normally?
Indirect taxes (& vice versa)
What 2 categories is government expenditure divided into?
1) Current
2) Capital
What is current government spending & an example?
Expenses of running a country from day-to-day e.g. paying wages of public sector workers
What is capital government expenditure and an example?
Expenses on improving the facilities to the public e.g. building better schools
Is capital expenditure just as important as current expenditure?
Yes
What can you do easily to capital expenditure?
Delay- in hard economic times it is often cut before the current expenditure
What is inflation?
A sustained increase in PL
What are the 3 key things in a budget?
1) G
2) T
3) Balance expected between G & T
What are the 3 possible outcomes to any budget?
1) Balanced budget
2) Budget surplus
3) Budget deficit
What is a balanced budget?
Where G=T- near on impossible
What is a governments realistic goal with a budget?
Make the gap between G & T as close to 0 as possible
What is a budget surplus?
Where T is greater than G (T>G)- government raises more in taxation than it spends in G
What is wrong with budget surpluses?
Difficult to justify politically
What is a budget deficit?
Where G is greater than T (G>T)- the government spends more in G than it earns in taxation (most common)
What is the most common outcome of a budget?
Budget deficit
Why does the UK spend more than it earns in tax?
1) Political judgements
2) Amount of demands placed on governments leads to constant ↑ in G e.g. ageing population ↑ NHS spending
How to governments finance a budget deficit?
Public-sector borrowing- Government bonds (low risk investment) loaned to government in return for an agreed rate of interest
What are government bonds (gilts)?
A low risk investment in order to reduce a budget deficit
What are the 3 elements to the budget?
1) G (government expenditure)
2) T (taxation revenue)
3) The difference between those
What is the definition of fiscal policy?
involves the government changing the levels of taxation and government spending in order to influence AD & the level of economic activity
What does expansionary fiscal policy involve/ lead to?
↑ AD so ↑ G & ↓ T which ↑ consumer spending due to higher RDI which leads to the government ↑ borrowing
What deflationary (tight) fiscal policy involve/lead to?
↓ AD so G is cut and T ↑ which↓ consumer spending due to less RDI
In what period is a expansionary fiscal policy used?
A recession
When do automatic stabilisers 1) increase & 2) decrease?
When the economy is 1) shrinking & 2) growing
What is the structural deficit?
The part of the deficit not related to the state of the economy & doesn’t disappear when the economy recovers
What is the cyclical budget deficit?
Considers fluctuations in tax revenue and spending due to the economic cycle
What is an example of a cyclical budget deficit?
In a recession, T falls and G increases so the size of the budget increases
What are automatic fiscal stabilisers?
Changes in the size of a budget deficit caused by changes in the economic cycle
What is the key factor to decide what fiscal policy to use?
Current position of the economy regarding the business cycle
What does the money borrowed to fund a deficit become?
Future national debt
What does borrowing money to fund national debt cause?
Huge opportunity cost- less spending available in future
What rules does the IMF recommend about budget deficits?
Budget deficit shouldn’t exceed 3% of GDP
National debt shouldn’t exceed 60% of GDP
What happens to the national debt if inflation is high?
Amount of money needed to be repaid is lower in real terms
Why do private sector businesses sell bonds?
Fund expansion, diversify and growth
What is crowding out?
The reduction of private sector investments induced by increased public sector investments
What happens if more people invest in government bonds?
Private sector investment decreases
Why may people invest in government bonds rather than corporate bonds?
Government bonds are safer
Why may increased government bonds actually decrease AD?
Less funds for business to invest (I) so less exports (X) and less employment so RDI (C)
Why is private sector investment (I) more efficient than government investment (G)?
Government failure- waste money due to no profit incentive
What are 2 weaknesses of crowding out?
1) If economy is weak & business confidence is low, private sector may not want to expand
2) Outweighed by crowding in effect
What is crowding in?
When higher government spending leads to an increase in private sector investment
What is the laffer curve?
A controversial economic theory that suggests tax rates above a certain level will actually reduce tax revenue as households/firms will go abroad
What are 4 strengths of fiscal policy’s effectiveness?
1) More direct than alternatives
2) Quicker than alternatives due to (1)
3) Can achieve all macro-objectives
4) Works well due to automatic fiscal stabilisers
Explain fiscal policy being more direct as a strength of fiscal policy
Government themselves create the extra AD & jobs- Can be effectively targeted at correct areas of the economy
Explain how achieving all macro objectives is a strength of fiscal policy
Expansionary FP may have crowding in & multiplier effect, leading to growth & low unemployment
Deflationary FP can stabilise prices, progressive taxes can keep fair income & subsidies can affect balance of payments
Explain automatic fiscal stabilisers as a strength of fiscal policy
Naturally adjusts in relation to the economic cycle e.g. in a boom G decreases and T increases
What are 4 limitations of fiscal policy?
1) Relies on good, sensible, well informed government
2) Crowding out
3) Disincentive effect
4) Expan. Fp increases national debt
Explain relying on a good, sensible well informed gvnmt as a limitation of fiscal policy
Government failure is an extremely common occurrence e.g. corruption, political priorities, info failure & inefficient procedures
Explain crowding out as a limitation of fiscal policy
Expansionary FP requires high gvnmt borrowing, leaving less for private sector access- more efficient have less finance & less efficient has more
Explain disincentive effect as a limitation of fiscal policy
Higher tax makes workers not work, businesses go abroad & reducing size of their operations- over reliance on gvnmt
Explain increasing national debt as a limitation of fiscal policy
Expansionary FP increases national debt= opportunity cost & has to be repaid in future instead of investing
When is expansionary fiscal policy most effective & why?
When in a recession (horizontal part of AS)- increases Y and decreases unemployment while maintaining low PL more
When is contractionary fiscal policy most effective & why?
When at YFE- decreases PL but maintains high real GDP (Y) more
