Fiscal and Supply-Side Policy Flashcards
Define fiscal policy
The manipulation of government spending and taxation in order to influence AD and the level of economic activity
What is budget deficit?
When government spending is greater than taxation
What is budget surplus?
When taxation is greater than government spending
What does PSDR stand for?
Public Sector Debt Repayment
Define PSDR
The amount of debt the UK government can pay off in any one period
What does PSNCR stand for?
Public Sector Net Cash Requirement
Define PSNCR
The amount that the government sector needs to borrow, over and above the tax revenue collected, to finance planned government spending
Define direct taxes
Taxes levied directly on incomes and profits
Define indirect taxes
Taxes levied on goods and services
What are the 3 largest categories of government spending?
Social protection
Health
Education
What does OBR stand for?
Office for Budget Responsibility
Give 3 of the main responsibilities of the OBR
Economic and fiscal forecasting
Evaluating performance against targets
Evaluation of financial risk
Scrutinising tax and welfare policy costing
Balance sheet analysis
Give 2 reasons why increasing the income tax rate past a certain point may decrease the tax revenue
Higher income tax rates decrease the incentive to work compared to lower rates
Higher tax rates can also lead to ‘brain-drain’ - where skilled workers begin to leave the economy
Explain what is meant by ‘crowding-out’
Increased borrowing by the government increases the rate of interest and reduces the funds available for private businesses to borrow and invest
What is the supply of loanable funds based on?
Based on savings
What is the demand for loanable funds based on?
Based on borrowing
Give and explain 2 reasons why crowding out is unlikely to occur in a recession
Low business confidence - so businesses and firms are unlikely to be willing to invest anyway
Lots of spare capacity in a recession - so firms do not need to invest anyway
Referencing interest rates, why may increased government borrowing lead to lower private spending and investment?
Increased government borrowing will lead to increased demand for loanable funds
This increased demand for loanable funds pushes interest rates upwards
Increased interest rates can hold back private sector spending and investment
Referencing spare capacity, why may increased government borrowing lead to lower private spending and investment?
When governments borrow to invest, it can utilise all the remaining spare capacity in the economy
Leaving few factors of production left for the private sector to employ for investment and expansion purposes
Referring to crowding out, why could it be argued that budget deficits are not desirable?
Budget deficits can be argued to be at the expense of private sector investment
Which can often be more productive than public sector investment
List 3 points of evaluation for crowding out
Crowding out doesn’t occur in a recession
Governments could borrow from the world’s financial market
‘Crowding-in’ effects
Explain why if governments were to borrow from the world’s financial market, crowding-out would not be as much of an issue
In the world’s financial market, the supply of money is relatively elastic
Thus borrowing here would not significantly increase UK interest rates that deter private sector investment
Explain ‘crowding-in’ effects
‘Spill-over effects’ from government investment
Technologies from government projects have applications in the private sector
What is meant by a structural budget deficit?
It is a budget deficit that will not disappear even when the economy is on the upswing of the economic cycle
The deficit isn’t linked to any stage of the economic cycle
What is meant by a cyclical budget deficit?
It is a budget deficit that occurs as part of the business cycle
Define austerity
Government policies to reduce government spending or increase taxation, in order to reduce budget deficits and attempt to control growing public debt
List 4 costs/negative of austerity
Can be self-defeating
Can cause some sectors to lose funding
Can reduce AD
May lead to brain drain
Explain how austerity can be self- defeating
If in a recession, governments who cut spending hard will see a large fall in nominal GDP
This will lead to a shrinking of tax revenues
Thus, austerity can reduce economic growth so much that the budget deficit fails to improve
Explain how austerity could lead to some sectors being underfunded, and the effect this would have on the macroeconomy
Such as a drop in spending on education and training
Could reduce LRAS, lower the productive capacity of the economy
Explain how austerity could lead to a reduction in AD, and the effect this would have on the macroeconomy
Increased taxes (a withdrawal) and decreased government spending (an injection) could reduce AD
This could lead to increased unemployment, decreased national income, the negative multiplier, etc
What is the KEY benefit of austerity?
Reduces national debt
List 3 benefits of austerity
Improves confidence
Reduces crowding-out
Reduces burden on future generations
Explain how austerity could lead to increased confidence in the economy
Cutting budget deficits will give investors greater confidence about the long-term performance of the economy
Lower debt levels will encourage more private sector investment
Explain how austerity reduces the burden on future generations
If the national debt continues to grow, this will be passed onto the future generation in the forms of higher taxes
Thus austerity can help prevent this from happening
List 2 points of evaluation for whether austerity is desirable or not
The current level of business confidence
The current state of the economy
Explain why the benefits/costs of austerity depend on the current level of business confidence
If there is high business confidence, austerity would be more desirable as lower government spending would be met with greater private sector spending
Explain why the benefits/costs of austerity depend on the current state of the economy
If in a recession, austerity is likely to just decrease AD, which is not beneficial
However, it would be beneficial for when the economy is overheating
Define market-based supply-side policies
Policies that remove or reduce government intervention and promote greater free market operation
Define interventionist supply-side policies
Policies that increase government intervention in the market through greater use of government spending, taxation or regulation
The difference between the natural rate of unemployment and the unemployment rate is caused by what?
The business cycle
Approximately, what is the natural rate of unemployment in the UK?
4 - 5%
