Fiscal And Supply Side Policy Flashcards
A country’s banking system is an important part of the institutional structure of its economy because of its role
As a source of investment funds for business
The consequence of increasing the interest rate when the exchange rate is rising is likely to be an increase in
A level of unemploymentr
A large increase in borrowing by consumers is most likely to lead to a
Rise in imports into uk
The monetary policy comm (mpc) of the boe meets each month to decide on the rate of interest that is most likely to help it achieve the gov inflation target
Mpc is most likely to increase interest rates if
The rate of growth of gdp is above the long term trend rate of growth
Expansionary monetary policy is most likely tgo
Shift ad curve to right
Monetary policy
Involves controlling the macroecon through changes in monetary vairables such as the money supply or interest rates
Changes in short term interest rates, principle tool of monetary policy in recent years
Ususally first line of defence
Easy to implement- meeting of mpc
Mpc
Monetary policy comm- bofe
Central ank not gov
Changed 19970- balir moved out as believed politicians were using monetary policy for political gain
How does monetary policy work
Aim to influence ad
Mpc sets interest ratee that it pays commercial banks on their deposits held at bofe
And rate it chanegs for short term lends to those same commercial banks and financial institutions
Bank rate
Bank rate sets the benchmark/base ratee for all other interest rates charged throughout banks system in uk
Changes interest rates inflluence ad via transmission mechanism of monetary policy
Time lags
May occur monetary policy- up to 2y before full effect of monetary policy will have its impact on whole economy
Aim gradually encourage consuemrs and busineses to adjust spending to keep inflationary prssure under control so econ can continnue to grow steadiily
Making forcasts of inflation and decide interest rate changes appropriate
But reaction of consumers and businesses to interest rates uncertain as are potential time lags 6
Interest rates for other banks/financial organisation
Depend on legth of loan and level of risk
Variety of interest rates paid to savers depends on sums of money deposits and ease of access
Interest rates do tent to move in same direction0
Impacts of changing interest rates on ad- via transmission mechanism- consumption
Increase interest rates, increase cost borrowing- therefore consumers borrow less to finance consumer spending on consumer durables- cars
Demand personal loans decreases0- consumers spend less on credit cards- w v high interst- 200%^
Encouragge save more- increase return
Discretionary income decrease as mortgage repayment increases
Cost of mortage increase, demand houses decreases, house pirces fall, wealth efecte worson
Mortagage equity withdrawal- mew- decrease- consumers fund spending by increasing sixe of their mortageg
Value of shhares on stock market most liekly decrease whhen interest rates rise- feel less welathy, decrease spending
Decrease consumer confidence- about future earnings or job security- act based on this security
Impacts of changing in interest rates on ad- investment
Business investment in new caputal decrease as incrase interest rates
As borrowing fund capital expendaiture increase
Decrease business confidence in future demand, decrease investment0- in new plant, machinery, companies, new buildings, infrastructure
Impacts of changes in interest rates on ad- via transmission mechanism- exports
Increase interest rates, increase change rate, decrease demand exports
Foreigners take adv of high interest rates and deposit cash with uk banks- increase demand sterling, hot money flows- cash for short term investment purpose
Reverse-if interest rates decrease- hot money flows out of pound sterling, decrease demand, depreciation of currency, demand exports increase esp demand elastic0- increase ad
Lras impact o f changing interest rates via transmission mechanism
Increase interest rates may damage the supply side of the economy by increasing cost of borrowing
Firms more diff to invest in new capital and r&d
Damage competitivee adv longer term
Economists argue uncertainty caused by accelerating inflation is likely to be even more damge to supply side of ecoomy in lr
Evaluation of effectiveness of monetary policy
Main objective of mpc to keep cpi inflation in line with target rate of 2%- aim promote macroecon stability
If mpc faills to keeep cpi inflation w/in target- govenor of bofe must make open letter of explanation to chancellor
Sucessful in demand pull inflation decreasing in recent years0
But blunt instrument when deealing with cost push- 20066-2008- iinflation increase due to cost push factors- oil and comodity prices (raw materials, wheat, copper)) increase
Less effective increase ad when stuck in recession and confidence - paradox of thrift
Could increase value of pound- decrease pirce imports
Examples of coost push inflation recent years
2011- 5.2%- commodity prices, weak pound, increase cost imports, gov increase vat to 200^%
Inflation peak 11.1^% oct 2022- high energy prices and wheat (r-u), weak pound- collapse confidence truss
Credit crunch- cost push 5.2%0- but bofe not increase interest rates so not push int o deeper recession
Paradox of thrift
Save rather spend
Job security- as firms cut costs as decrease ad- cut back spending
Made redundancies- cant spend more
Wealth efect- assets stocks and property decreae value prce
Fiscal policy
Use of taxation, gov spending and gov borrowing to achieve macroecon obejctives
Fiscal automatic stabilisers
Dont require any change in gov polciy
Therefore not considered expansionary or contractionary fiscal policy
Automatic stabilisers- output fall
Tax revenue automatically decrease
Incomes and revenuue decrease when ad fall
Lower income, lower tax rates
Gov spending increase automatically, increase welfare and unemployment beneffits
Automatic stabilisers- output increase
Tax revenue increase
Income tax and firms revnuue increase0 move higher tax bracket
Welfare fall
Blair gov- auutomatic stabilisers?
No resorted to active or expansionary fiscal policy to deal with credit crunch recession in 2009
Direct taxation
Largely taxes on income paid directly to gov by individual tax payer
Income households and coperations
Tax liability cannot be passed onto others q
Direct tax rates
Personal tax allowance- 12.5k
Income tax rates, 00%, 20%(above 12.5), 40% over 50k, 45% over 150k but loose tax allowance over 100k
National houshold contributions on workers
Why may a gov wish to increase income tax
Increase rveenue to avoid borrowing when increase spending
Decrease ad- contractionary fiscal policy- decrease disposable income- ad falls as consumer spending a componeent of ad
If progressive- increase equality as redistribution of wealth
Indirect taxation
Largely on spending
Vat 20%^
Excise duties- tobacco, alcohol, sugar, tax, fuel duties - demerit goods
Depends on price leasticity and supply for good- firms may be able to shift burden of tax onto consumer
Recent decades- shift away from using direct taxations as part of discretionary fiscal policy
Adv indirect taxation
Influence spending pattern
Correct externalities
Incentive effect
Flexibility
Indirect tax- influence spenidng patterns
Indirect tax changes are arguably more effective in changing overall patterns of demand for particular g
Change relative rpices and discourage consumption of demerit goods
Indirect tax- correct externalities
Indirect taxes for negative externalities
The polluter pays principel for internalising external cost of production and consumption
Incentive effects- indirect tax
Indiect taxes have less impact upon individual work v leisure changes
May increase indirect taxes rather than direct tax flexibility
Disadv indirect tax
Distribution effects- regressive effect of many indirect taxes to make disrtibution of income more unequal
Inflationary pressures- increase can trigger cost push inflation
Crime- create incentives to avoid indirect taxes- eg smuggling ciggarettes
Stealth taxes- lack of announcement means people unaware of how much pay in indirect atxes- goes against ‘certainty principle’ of good tax system
Proportional tax
Everybody pays ssame % of their income
Egg russia at 13%
Progressiive taxation
More earnt, bigger ^% of income spent in tax
Uk
Regressive taxation
Low income groups pay bigger proportion of incomee in tax
Criticism of indirect tax- vat
Main objectives of uk tax system
Funds gov spendng- able to borrow moeny up to a certan extent but majority must come from taxation to avoid inflationary pressure
Manage economy as a whole- macroecon performance- eg alter taxes and rates to influence econ growth , inflation, unemployment, bop
Decrease certain tax- microecon supply side benefits such as more incentives
Redistribution of iincome- fairness in society
Correct market failure- micro econ improvement workings of market, indirect taxes on demerit goods fund to decrease negative externalities
Horizontal equity
Where people or firms with same income and financial circumstances pay same amount of tax
Verticle equity
When amount that people pay is based on their ability to pay
High income groups pay income more than low incomes
Principles of taxation
Decide if tax is good or bad from economic pov
Economical
Equity
Convevnience
Certainty
Efficiency, flexible- modern principels, ones above canons
Economical taxation
Tax should be simple and easy to colect
So revenue is maximised compared to coost of collection
Equity taxation
Taxes should be fair and based on taxpayer ability to pay
Justification for progressive nature of income tax
Horiontal and verticle equity
convenience of taxation
Payment method and timing should be convenient to the taxpayer
Certainty of taxation
Tax payers hsould understand how system works
Cleaer, what, when and how to pay
Taxes diff to evade
Efficient tax systeem
Meets its aims whilst minimising neagtive distortions
Eg decrease individual incentives to work save and invest
Flexible tax system
Structure and rates of taxation must be capable of easy alteration in responsible to changing economic conditions
Hypothication of taxes
Taxes raised for specific purpose- revenue earmarked for particular use
Large proportion of tax on cigarettes for smoking related disorders
Reveal how much individuals are prepared to pay for partiuclar services- if still ocnusme
Eg,. Tv licnce0- tax cover cost of bbc
Pigouvian taxes
Take money from those creating negative externalities
Spend revenue on compensating those who suffer the spillover or r=negative consequencees
Some argue fuel tax and improt tax used to subsidise investment in alternatives to fossil fuels
Benefit principel
Argument taxes should be linked to the benefits that taxpayer recive from teh tax
Gov spending categories
Current spenidng0
Capital spending
Transfer payments
Current spending- gov spending
Wages public sector wrkers and consumables- medicine in hospital
Less sensible to borrow for
Capital spending
Spending on infrastructure
Growing economu by increasing productve capacity, supply side0
Building schools, hospitals
More sensible to borrow for - long term benefits
Transfer payments0- gov spending
Transer of income from tax payers to those recieving beneifts/pensions
One group to another
Budget deficit
Occur when gov spending exceeds gov rev from taxation and other sources of income- eg. Prescription charges
Borrowing for just one yeaar
Budget surplus
Gov revenue exceeds gov spending
Balanced budget
Gov revenue equals gov spenidng
Last seen in 2000-2001
How to fix budget deficit
Eliminate by cut back public spending or raise tax- long term implications
Infrasturcture less- damage supply side
Increase tax- decrease incentive work save and invest
If budget surplus- how to fix
Gov use exess rev or other expendaiture to repay preious borrowing
Private sector debt repayment- psdr
National debt
Accumulated borrowing
How much state owes
Peaks in wars and recessions
Cyclical deficit
Gov in debt during recession
Structural deficit
Gov in debt during growth phase
Current spending
Expansionary fiscal policy
Discretionary /active fiscal policy
Deliberate chanegs in direct/indirect taxation and gov spenidng to influence ad
Successful 1949-79
How expansionary fiscal policu works
In recession gov boost public spendng/cut direct taxes to stimulate ad an set off positive multiplier
Cut income tax- expansionary fiscal policu
Give consumer more disposable income- increase demand for sonsumer g&s
Retailer increase order from manufacturer- take on more workers, increase investment, more capital spending
Demand new premises, factories and homes increase- increase consumption workers
Net injection exceed net withdrwawal positive multiplier
Increase sales- firms more profitable and falling unemployment means income increase
Increased income from employyment and dividens from rising profit- increase ad until econ settle at higher equilibrium
Cut vat- expansionary fiscal policy
Hope decrease prices would encourage consuemrs to spend more on other g&s boosting ad
Cut cost in production
Eg. In 2009 lack of confidence- cut vat from 17.5 to 15%^ rather cut in direct tax
Increase gov spending on infrastructire projects- expansinary fiscal policu
If felt that tax saved or spent on imports
Eg build road andd rail networks- Increase effieciency in transport
Or build new schools and hospotal- expanding social capital
Both create work for construction workers- increasing iincome
Some extra income spent local g&s creating more jobs and income and profitcs- positive multiplier (iff injections exceed withdrawals) increase gdp
impact increase gov spending- expansionary fiscal policu
Increase in recession- counteract. Fall in public spening
Important debt repayed when economy recover
High levels of borrowing in econ danger- crowding out effect
Adv cut direct taxes
Increase spending as disposible income increases
Increase mpc- positive multiplier if increase net injections
Ad to right
Disadv cut direct taxes
Lead to increase psnb
Decrease rveneu
Additional money saved or pay off existing debts- paradox of thrift
Spent imports- not beneficial to local g&s- no increased incentive for firms to invest
Pro cut indirect tax
Sras to right- cut cost of production
Increas ad as less expensive- increase spending on other g&S
Disadv cut indirect taxes
May lead to increase psnb
May increase demand demerit goods
Increase gov spending adv
Road and rail network improved- transport mroe goods, decrease cost for firms
Expand social capital- new schools and hospitals
Creates jobs workers, boosts income, spent local g&s, creating more jobs, further boost income
Lras to rght- long term benefit- supply side
Multiplier and create more jobs
Increase gov spending- disadv
Increae psnb
Time lags- planning permisson and get programmes started- eg in 2009 recession- labour bought forward infrastructure n pipeline
Crowd out private sector spending and investment- damage competitiveness in industry longer term
Multiplier effect
Increase gdp+ multiplier x increas enet injections into circular flow of inocme
1=mps+mpt+mpm+mpc
Multiplier = 1/1-mpc = 1/mps+mpm+mpt
Negatiev multiplier
Decrease gdp= increase net withdrawals x multipier
Effectiveness of expansionary fiscal policy depends on
Multiplier efect
If have higher margiinal propensity to consumer- higher multiplier
History of fiscal policy- 1945 to 1970s
Discretionary expansionary fiscal policu
Sucesfulin keeping unemployment low and stable economic growth
1970s oil price crisis
1979-1008 fiscal policy istory
Automiatic stabilisers not effective
Stagflation- increase unemployment, increase accelerated cost push inflation
End of 1970s- expansionary- artificiail econ growth when supply side econ (structural weakeness) unable to grwo fast enough for existing demand
Poorly judged and misused00- accelerating inflation and increase inports ‘unecessary and decrease cmpetitiveness of british businesses
Recession 2000/01- fiscal policy history
Collapse dot com bubble and 911
Bush cut tax and increase spending-sucess
Uk econ-avoid recessioin-supply side fiscal rather expansionary fsical
Not structural deficit as capital not current spending
2009 credit crunch recession-fiscal policy
Lbaour use of expansionary
Positive multiplier to lift out
Infrastructure projects bought forward and bail out banks
Psnb increase- current capital and tranfer (increase unemployment
2010-2016 fiscal
Osbiurne cut budget
Austerity decrease gov spending
Cut welfare 26k to 20k max
Vat increase 17.5 to 20%
Cut local authoritie -libraries
Cut surestart scheme -intridyce more single motehrs into work with better childcare
Contractionary fiscal policy
Decrease ad ti decrease inflationary pressures
Increase direct tax, decrease disposabke inckne- decrease ad when in positive output gap
Single currency
Used in european single currency
Reduce domestic inflation
Us firms took adv of ireland in single currency
Increase fdi- foreign direct investment, increase net injection , positve multiplier, increase gdp, positive output gao, fuel inflationary demand ohkk
Increase direct tax to redhce ad
Fiscal supply side policies
Aim to shift lras to right
Increase efficiency and boost productive capacity
Largely targeted private sector aiming to improve quality factor inputs- esp capital labour and entrepreneurship
More poduction at lower price level
Main categories of supplyy side policies- not all fiscal
Competition policy
Increase incentives to work save and invest
Creation more flexible labour market
Policies to encourage increased investment in infrastucture and r&d
Creation more flexible labour market- supply side
Eg deregulation- easier to hire and fire staff, increase spending on education and training - fiscal
Competition policy
Deregulation
Decrease barriers to entry
Make markets more competitive- eg privatisation
Increase incentives to work save and invest- supply side
Lower taxes- high income- save, low- no work
Decrease welfare benefits- welfare refomr, decrease replacement ratio
Policies to encourage increased investiment in infrastructure and r&d- supply side
Subsidies (gov pays) or tax break for r&d- inflation reduction plan biden
Provided directly- gov spending- fiscal
Telecoms, ewater, electricity
Fiscal supply sider policies
Decrease direct tax or increase tax allowances
Changes to welfare benefit system
Increased spendiing education and training
Increased capital spending infrastructure
Encourage investment in r&d
Decrease direct tax or increase tax allowances- fiscal supply side
Enhance incentive to work save and invest, lower unemployment trap
Increase save- banks more cash to lend to businesses and entrepreneurs
More busiinesses ratani more profit for reinvestment
Shareholders retain more dividens, encourage individuals to invest in cpmanies by-purchasing stocks
Important taxes arent reduced so much that gov no revenue to deliver effective public services
Changes to welfare benefit system- fiscal supply side
Increase incentives find work, decrease uneemployment trap
Thatcher- increase benefits in line with inflation rather av earnings
Blair- working tax credit meant workers recieived extra benefits
Incapacity benefits decreaes for thhose deemed less sick and capable of carying on with soem sort of wokrk
Current con gov- decrease working tax credit, raise national living wage to 10.42 pounds
Taxpayer not subsidising underpaying employer
Welfare benefits combined uc- no more than 20k per year
increase spending education and training- fiscal supply side
Increase occupational mobility
Increase efficiency and effectiveness of labour in lr
0v expensive and time lag
Current con gov- apprenticeship levy give large firms funds to train mroe employees
Encourage investment in r&d- fiscal upply side
Gov fund r&d in defence o rhealthcare
Tax credit, tax allowances, gov grants (subsidies, influence q+q of r and d by prvate sector
V expensive and diff enforce patents on international market
Effectiveness of supply side policies- free marketeer
No-classical
Private sector more likely to deliver technical and allocative efficiency
Concerned risk gov failure
Keynsian interventionist approach to supply side policies
Market failre concern
Carefully target gov spending n merit goods and infrastructure, r&d, education and training
Lead to crowding in effect- firms attracted to areas with good infrasturcture, good controls within r&d and more skilled workforce
Crowding out effect
Gov spending/borrowing displaces private sector spending/borrowing
Increase gov borrowing, increase interest rates, increase cost of borrowing private esector jobs, deter from investing, decrease ad in short term
Longer term- low levels of investment- less competitive industries, decrease domestic sales and exports, decrease econ growth lr
Keynsian argument of crowding out efefct
Sensiblee borrow in recession
Injection compensating decrease private sector spending
During recession, privaet sector, investment falls
Most economists wouuld argue that crowding out effect
Takes place during period of econmic growth
Fund current expendaitrue- unsustainable in lr0- structural budget deficit
But if on capital- kensians may argue- then justified as leads to stronger econ growth i n longer term
Neutral fiscal stance
Gov runs a balanced budgeht
Designed to have a benigni mpact on level of econ activity
Demand management
Influence level of ad in econ
Eg through contractionary fiscal poliu
Create greater stability and smoothing out fluctuations in econ cycle
Eg inject extra demand - cut in taxes or increase gov spending- when private sector demand too low- opp if demand pull inflation
In past- gov attempt to fine tune econ by fiscal policy- most accept now not so precise
Psnb
Public sector net borrowing
Diff between tax rev and gov expendatityre
Borrow from banking sector or non bank private sector- insurance companies, pension fynds, hedge funds, individuals- sell bonds
Benefits of budget deficit
Finance capital spending- eg build new roads ro schoools- boot lr supply side of econ- brown justify post 2001
Keynsian- yes- boost ad to lift out of recesion
An increase in teh exchange rate is most likely to contribute to
A reduction of inflation
Public expenditure is gov spending on goods and services folllowing their consideration of
Collective needs
A structural budget deficit can occur when
The econ is at full emp
If there is a budget deficit that is addressed by the gov increasing tax the likely impact of this measure to rebalance the budget is
Reduced ad
Tax against multinational often avoid
But under oecd rule smust prove that pay at least 15% tax rate in each and every couontry they operate
Estimates it would raise 220bn dollars globally per year
Inhibitiing factors to global consistent tax
Ie saudi arabia does not even have corpoerate tax system but instead has a tax system based on islamic principles
