Fiscal Policy

Question 1

What is the budgets three fold purpose

Answer 1

• Decides how revenue will be raised and allocates funds to areas of need (determined by on-going funding needs, driven by the political process – as the government day needs funds to support its initiatives)
• The budget redistributes income, mainly using progressive income tax
• The government can use the budget to influence the level of macroeconomic activity

Question 2

what does the outcome of the budget peer to?

Answer 2

The ‘outcome’ of the budget refers to the relationship between government revenue and government spending.

Question 3

what are the three outcomes of the budget

Answer 3

• If revenue and expenditure are equal, the budget is in balance
• If revenue is greater than spending, the budget is in surplus
• Should spending exceed revenue, the budget is in deficit

Question 4

when is a surplus planned?

Answer 4

A surplus is planned when levels of economic activity have been high, and a deficit budget is necessary in an economic downturn

Question 5

reasons why the actual budget result will differ from the planned outcome

Answer 5

• Should there be a downturn in economic activity, business conditions would be tougher and tax revenue from households and businesses would fall. Therefore, the actual deficit would be worse than planned
• An unanticipated upswing after the budget is announced, would result in rising government revenues and lower spending. The outcome would be a smaller deficit than that planned
• Changes In conditions of world markets could impact the budget outcome

Question 6

what can surplus funds be used for?

Answer 6

Surplus funds can be used to reduced debits from past deficits or could held over to fund future expenditure, or returned to taxpayers through tax cuts or direct payments.

Question 7

what does a budget deficit allows the community to do

Answer 7

A budget deficit allows the community to consume goods and services now and pay for them in the future

Question 8

what are the ways a government can finance a budget deficit?

Answer 8

• sell government bonds
• borrow from the central bank
• borrow from overseas
• sell government assets

Question 9

what is a bond

Answer 9

• A bond is a finical instrument which rises funds for its issuer, in return a rate of interest payable to the buyer.

Question 10

why would the government borrow money from the central bank to finance a deficit?

Answer 10

New money is injected into the economy. This may have the desired expansionary effect on the economy, but the increase in money supply will have an inflationary impact if the growth in money supply exceeds the growth in real output

Question 11

what would happen if the government borrowed money from overseas in order to finance a deficit?

Answer 11

Doing so would not increase the money supply under Australia’s system of floating exchange rates, but the exchange rate would appreciate due to the inflow of money capital. Exchange rate appreciation makes exports less competitive and imports more competitive against domestic goods

Question 12

what is ‘crowding in’

Answer 12

Retiring debt means that bond holders are repaid the capital value of their bonds, giving them extra spending power

Question 13

what is the aim of the countercyclical policy?

Answer 13

The aim of countercyclical policy is too ‘smooth’ the ups and downs of the business cycle

Question 14

what will happen if the economy is in the trough phase of there cycle?

Answer 14

tax revenue falls and welfare payments rise, so the budget balance moves towards a deficit

Question 15

what happens If the economy is in a boom or stronger cycle?

Answer 15

tax revenue rises and welfare payments fall, so the budget balance becomes increasingly positive

Question 16

what did income taxes and welfare payments do in a boom and a trough?

Answer 16

reduce the level of aggregate spending in a boom, and increase it in a trough

Question 17

what don’t automatic stabilisers do?

Answer 17

do not prevent fluctuations in the business cycle, and are not by themselves sufficient to completely counteract the peaks and troughs in economic activity

Question 18

what is discretionary fiscal policy?

Answer 18

Discretionary fiscal policy refers to changes to expenditure and revenue that the government makes in the budget to stabilise the economy

Question 19

what is the expansionary policy stance?

Answer 19

In a period of slow economic activity, it is appropriate to use an expansionary budget to stimulate spending

Question 20

what are the policy measures to stimulate household and business spending?

Answer 20

• Reducing income tax to increase household purchasing power
• Cutting corporate tax to stimulate business spending on inputs, employment, and investment
• Increasing government spending on infrastructure

Question 21

when is an expansionary policy usually used for

Answer 21

• An expansionary policy is usually associated with a deficit budget
• Planned expenditure is higher than revenue
• If revenue falls as expenditure rises, an expansionary policy could be used in surplus

Question 22

what does a expansionary policy do

Answer 22

• Expansionary fiscal policy gives households more disposable income
• Company taxes could also be reduced to allow firms to retain profit
• The level of economic activity should therefore rise and a return to full employment levels of expenditure, output and income should occur

Question 23

what does the expansionary policy do on a AD/AS model

Answer 23

Expansionary policy in periods of low economic activity is designed to bring about an increase in AD from AD1 to AD2. Levels of real output rise from Q1 to Q2

Question 24

what is the contractionary policy stance

Answer 24

In a period of stronger economic activity, it would be appropriate for the government to plan a budget surplus to reduce levels of spending in the economy

Question 25

what are there three policies of the contractionary stance

Answer 25

• Increasing personal income tax and company tax
• Reducing or postponing spending on major projects
• Increasing excise taxes (sales of cars, tobacco, and alcohol)

Question 26

why does the government use this contractionary policy

Answer 26

• In a boom, the government uses its budget to counter the inflationary gap – can be achieved through raising taxes and/or reducing spending
• Contractionary fiscal policy reduces households’ disposable income, so aggregate consumption should fall

Question 27

what does the contractionary policy look like on an AD/AS model

Answer 27

Assume the level of AD was AD1, the associated level of output is Q1 which is beyond the economys full employment potential, placing upward pressure on prices. Reduced government spending and/or increased taxation will have a contractionary effect on aggregate demand, shifting the AD curve to the left. Real output will fall to Q2 and the price level will fall to P2

Question 28

what is the neutral budget stance

Answer 28

If the government thought economic conditions were close to the natural rate of employment with inflation in the 2-3% range, it might adopt a neutral budget stance – little difference between planned revenue and spending, and the budget outcome would move towards balance

Question 29

what are some strengths of fiscal policy

Answer 29

• Fairly direct – revenue and spending measures announced in the Budget can be implemented immediately, consumers feel impact immediately
• Can be targeted to impact on specific sectors of the economy, and can also affect aggregate supply by for example, spending on infrastructure projects
• Its effect on the economy in recession – the government can open a ‘spending tap’ to increase the level of AD in the community
• Well-timed fiscal policy measures and automatic stabilisers are complementary
• In a boom, both discretionary and automatic stabilisers dampen spending and economic activity
• In a downturn they act together to stimulate spending and economic activity

Question 30

what are some weaknesses of fiscal policy

Answer 30

• Time lags
• Recognition lag – policy making is out of date
• Decision lag – time passes as policy is being created
• Impact lag – time taken for policy to make an impact on level of economic activity
• Relatively inflexible
• Social, democratic, political constraints
• Governments seek re-election, in years proceeding elections they create easier policies to attract voters
• Unintended impact on decisions taken in the private sector – ‘crowding out’ could have negative effect on firms because the availability of loanable money falls and its price (interest rate) is higher