Fiscal and Supply Side Policies Flashcards
What does fiscal policy involve
the manipulation of government spending, taxation and the budget
balance. It can have both macroeconomic and microeconomic functions.
what are the instruments of fiscal policy
Government spending and taxation
-they can change the amount of spending and taxation to stimulate the economy (increase or decrease AD)
the government can influence the supply of the circular flow by changing the government budget, and spending and taxes can be targeted in areas which need stimulating
what does fiscal policy aim to do
Fiscal policy aims to stimulate economic growth and stabilise the economy.
what does expansionary fiscal policy aim to do
aims to increase AD
done by increasing government spending or reduce taxes
costs of using expansionary fiscal policy
leads to a worsening of the government budget deficit -> may mean governments have to borrow more to finance this
what does contractional fiscal policy aim to do
aims to decrease AD. Government cuts spending or raise taxes, which reduce consumer spending, leading to an improvement on the government’s budget deficit
how fiscal policy can be used to influence AS
the government could reduce income and corporation tax to encourage spending and investment
the government could subsidise training or spend more on education -> lowers costs for firms (they will have to train fewer workers) -> spending more on healthcare helps improve the quality of the labour force -> contributes towards higher productivity
governments could spend more on infrastructure -> such as improving roads and schools
when does government have a budget deficit
when expenditure exceeds tax receipts in a
financial year
when does a government have a budget surplus
when tax receipts exceed expenditure
what is debt
The debt is the accumulation of the government deficit over time
the deficit/surplus is
the difference between expenditure and
revenue at any one point
what are direct taxes
Direct taxes are imposed on income and are paid directly to the government from
the tax payer.
e.g. income tax, corporation tax, inheritance tax
what are indirect taxes
Indirect taxes are imposed on expenditure on goods and services, and they increase
production costs for producers.
This increases market price and demand contracts.
what are the two types of indirect taxes
Ad valorem taxes are percentages, such as VAT, which adds 20% of the unit
price. This is the main indirect tax in the UK.
Specific taxes are a set tax per unit, such as the 58p per litre fuel duty on
unleaded petrol.
what are proportional taxes
A proportional tax has a fixed rate for all tax payers, regardless of income. It is also
called a flat tax.
For example, all tax payers might have to pay 20% income tax rate.
what is a progressive tax
an increase in the average rate of tax as income increases. As
income increases, the proportion of income taxed increases.
what is a regressive tax
A regressive tax does not relate to income, but means those on lowest incomes have
a higher average rate of tax.
In other words, the proportion of income paid as tax is
higher for those on lower incomes than those on higher incomes.
what are the limitations of fiscal policy
Governments might have imperfect information about the economy. It could
lead to inefficient spending.
There is a significant time lag involved with employing fiscal policy. It could
take months or years to have an effect.
If the government borrows from the private sector, there are fewer funds
available for the private sector, which could lead to crowding out.
The bigger the size of the multiplier, the bigger the effect on AD and the
more effective the policy.
If interest rates are high, fiscal policy might not be effective for increasing
demand.
If the government spends too much, there could be difficulties paying back
the debt, which could make it difficult to borrow in the future
what is crowding out
Governments might have to fund its spending using taxes or running a budget
deficit. This leaves fewer funds in the private sector for firms to use, since the
government is borrowing money, which crowds them out of the market.
When the government borrows a lot of money, interest rates might increase.
This discourages spending and investment among the private sector.
Productivity and growth
Level of taxation
Equality and living standards
The consequences of budget deficits and surpluses for macroeconomic
performance.
A fiscal deficit could be inflationary if it increases AD.
More government spending could lead to crowding out of the private sector. This
leaves fewer funds in the private sector for firms to use, since the government is
borrowing money, which crowds them out of the market.
It could lead to increased interest rates. This is because the government has to offer
investors an attractive rate in order to encourage them to buy the debt.
The significance of the size of the national debt
The cost of borrowing could increase, since by borrowing money, the government is
increasing demand for credit in the economy.
If confidence is lost in the government’s ability to repay the debt, governments
might have to raise interest rates to encourage investors to buy bonds, so that they
can finance the debt.
It could lead to higher taxes and austerity measures, especially if the debt becomes
uncontrollable.
The role of the Office for Budget Responsibility
The OBR provides analysis of the UK’s finances.
They produce 5-year forecasts for the economy, including the impact of tax and
spending changes announced in the Budget.
They judge the government’s performance against its fiscal targets. These are to
balance the budget 5 years ahead and have net public sector debt falling in 2015-16.
They assess the likelihood of the government meeting the targets.
They scrutinise tax and welfare spending measures.
They also assess how sustainable public sector finances are in the long run.
what is a cyclical deficit
This is a temporary deficit, which is related to the business cycle. A deficit might
occur during recessions, when governments increase spending to stimulate the
economy.
what is a structural deficit
This is a deficit which is due to an imbalance in the revenue and expenditure of the
government, so it exists at every point in the business cycle.
what do supply-side policies aim to do
they aim to improve long run productive potential of the economy.
what are the strengths of supply side policies
Supply-side policies are the only policies which can deal with structural
unemployment, because the labour market can be directly improved with education
and training.
what are the weaknesses of supply side policies
Demand-side policies are better at dealing with cyclical unemployment, since they
can reduce the size of a negative output gap and shift the AD curve to the right.
There are significant time lags associated with supply-side policies.
Market-based supply-side policies, such as reducing the rate of tax, could lead to a
more unequal distribution of wealth.
what are the two types of supply side polices and distinguish them
market based supply side policies - limit the intervention of the government and allow the free market to eliminate imbalances
interventionist supply side polices - rely on the government intervening in the market
what are some market based supply side policies
reduce income and corporation tax -> encourage spending and investment -> increase the long run productive potential of the economy -> improves the underlying trend of economic growth
deregulating or privatising the public sector -> firms can compete in a competitive market -> which should also help improve economic efficiency
reducing the NMW -> allows free market forces to allocate wages and the labour market should clears. Reducing trade union power makes employing workers less restrictive and it increase the mobility of labour -> makes the labour market more efficient
what are some interventionist supply side policies
a stricter government competition policy -> could help reduce the monopoly power of some firms + ensure smaller firms can compete too
subsidise the relocation of workers -> improve the geographical mobility of labour + increasing information provision by improving the availability of job vacancy information
subsidise training or spend more on education -> lowers costs for firms as they would have to train fewer workers
spending more on healthcare -> helps improve the quality of the labour force + contribute towards higher productivity
governments could spend more on infrastructure -> such as improving roads and schools
