Fiscal and supply side policies Flashcards
What is fiscal policy?
Fiscal policy is the taxation and spending measures that allow the government to guide the economy.
2 examples of government spending that affect AD in the short-run and the supply side in the long-run.
1: Increase expenditure on training+education would cause an increase in AD as well as a fall in structural unemployment after a number of years.
2: Increased expenditure on infrastructure would cause an increase in AD and also improve the productive capacity when the changes in infrastructure are complete.
Chain of reasoning for the effect of a fall in corporation tax on the LRAS curve.
Cut in corporation tax, higher retained profits, higher investment, increased productivity (and thus increased productive capacity and an increase in AD)
Chain of reasoning for the effect of a fall in income tax on the LRAS curve.
Cut in income tax, increased incentive to work, frictionally unemployed people take jobs and economically inactive people enter the workforce, increase in the capacity of the economy.
What is a short-run problem of using fiscal policy to increase the capacity of the economy?
If there economy is near or at capacity, there will be demand-pull inflation in the short term while the policies take effect on the supply-side.
What are transfer payments?
Transfer payments are government welfare payments that do not require economic activity in return.
What is current government spending?
Current government spending is spending on state-provided goods and services that are provided on a recurrent basis e.g. salaries for people working in the NHS.
What is capital government spending?
Capital spending is government spending on the economy’s capital stock e.g. on infrastructure
What are the 4 main reasons for taxation?
- Raise revenue to allow government spending
- Manage the economy as a whole
- Change the distribution of income and wealth
- Correct market failures
What is a proportional tax?
A proportional tax is a tax with a constant marginal rate of tax.
What is public sector net borrowing?
Public sector net borrowing is the amount by which government expenditure exceeds taxation revenue.
Chain of reasoning for increase market rates of interest due to a large budget deficit.
Large budget deficit, increase in supply of government bonds, fall in the price of bonds, increase in bond yield, fall in demand for savings, increase in market rates of interest (e.g. for mortgages)
What is crowding out?
Crowding out refers to the problem that more government spending may lead to less private sector spending (consumption and investment) this leaving aggregate demand unchanged.
What is financial crowding out?
Financial crowding out is when government spending increases interest rates, thus causing consumption and investment to fall.
Chain of reasoning of financial crowding out.
Increase in government spending, rising budget deficit, higher market rates of interest, fall in consumption and investment, AD remains unchanged.
