Fiscal Policy

Question 1

Fiscal policy

Answer 1

The taxation and spending decisions of a government

Question 2

Expansionary fiscal policy

Answer 2

Designed to increase AD

Question 3

Contractionary fiscal policy

Answer 3

Designed to reduce AD

Question 4

3 main areas of Government expenditure

Answer 4

1) Capital expenditure - improving the capital stock of the country
2) Current expenditure - running public services day to day
3) Transfer payments - benefits

Question 5

Progressive tax

Answer 5

A larger percentage of income from high-income

E.g. UK income tax

Question 6

Proportional tax

Answer 6

Same percentage of income from all income groups

E.g. In Russia, there is a flat income tax rate of 13%

Question 7

Regressive tax

Answer 7

A tax that takes a larger percentage of income from low-income groups
E.g.Poll tax

Question 8

What are the 2 types of tax

Answer 8

Direct tax - on the income or profits of the person who pays it
Indirect tax - on the goods and services

Question 9

Examples of Direct tax

Answer 9

Income tax
Corporation tax
Inheritance tax
Capital gains tax

Question 10

Examples of indirect tax

Answer 10

VAT
Excise duties
TV licence
Car tax

Question 11

What is a budget deficit?

Answer 11

Government spending more that they receive in taxes. Borrowing needed

Question 12

What is a budget surplus?

Answer 12

Government spends less than they receive

Question 13

What is a balanced budget?

Answer 13

Government spend the same as they receive in tax

Question 14

Budget deficits expansionary…

Answer 14

…wants to increase AD, borrow to find this

Question 15

Budget surplus contractionary…

Answer 15

…wants to reduce AD e.g.reduce spending

Question 16

Balanced budget neutral fiscal…

Answer 16

…not trying to influence AD

Question 17

Two reasons for why governments operate a budget deficit?

Answer 17

1) Cyclical

2) Structural

Question 18

Cyclical

Answer 18

The government needs to respond to the economic cycle. Obliged to run a deficit
E.g. to help the economy cope with recessions

Question 19

Structural

Answer 19

When the economy is at full employment

Choosing deliberately to run a deficit

Question 20

A good tax must be?

Answer 20

Convenient
Must be certain, no surprises
Must be fair/equitable (based on the ability to pay)

Question 21

Automatic fiscal stabilisers

Answer 21

In a recession, tax revenue is falling but increased government spending on benefits, will help stabilise the economy

Designed to damp down fluctuations

Question 22

A deficit is…

Answer 22

…current, how much the government will borrow this year

Question 23

Debt is…

Answer 23

…constant for example - 20 years continuous deficits

Question 24

Austerity

Answer 24

Cutting back on public spending - may lead to a recession

Question 25

Solutions if the deficit gets too big

Answer 25

1) Increasing tax levels-very unpopular
2) Austerity - cutting back on public spending, may lead to a recession
3) Boost economic growth e.g. replacing current expenditure with capital expenditure

Question 26

What is national debt?

Answer 26

Is made up of all the money borrowed by the government over the last 50 years or so

Question 27

Problems with expansionary fiscal policy

Answer 27

1) Adding to the National Debt
2) Time lags and inflexible - may take too long to be effective
3) Depends on the multiplier but this is uncertain and unreliable
4) May lead to “crowding out”

Question 28

What is crowding out?

Answer 28

economic theory arguing that rising public sector spending ‘crowds out’ private sector spending.

Question 29

Two ways of causing contractionary fiscal policy?

Answer 29

1) Raising taxes

2) Reducing G

Question 30

Total government debt must not be more than…

Answer 30

…60% of GDP

Question 31

Government deficit must not be more than…

Answer 31

…3% of GDP except from particular circumstances

Question 32

Reason for fiscal rules

Answer 32

Fiscal rules put pressure on governments to stick to fiscal responsibility. If countries stick to fiscal rules, markets will have more confidence

Question 33

Problems with fiscal rules

Answer 33

Lack of flexibility. Time frame may be unsuitable for the state of the economy

Question 34

Main strength of fiscal policy

Answer 34

Direct. It can be specifically targeted at groups in most need and is fast acting (e.g.Furlough Scheme) more suited for deep recessions or emergencies

Question 35

Main weakness

Answer 35

Government failure! Government often make very bad decisions, sometimes for political, not economic reasons. FP can also be bureaucratic (complex and long)

Question 36

If the government finances its budget defict through borrowing, what could the side effect be?

Answer 36

Is to put upwards pressure on interest rates, which then may cause private sector spending - households consumption and firms investment - to decrease as the cost of borrowing has increased. This process is known as crowding out

Question 37

How would the ‘crowding in’ effect occur?

Answer 37

If the government runs a surplus and therefore puts downward pressue on interest rates. ‘Crowding in’ public sector activity

Question 38

Reasons for contractionary fiscal policy?

Answer 38

• Reduce Budget Deficit/National Debt

- Redistribute income (imposing increase in progressive taxes) reducing income inequality

Question 39

The effectiveness of fiscal policy if already at YFE?

Answer 39

Ofher policies to consider, as Fiscal Policy is a demand-side policy meaning the economy cannot grow any larger but implementing policies that affect AD.

Thefore other policies such as supply-side policy which affect supply. This could shidt LRAS right which would expand the economy, due to the increase in productive capacity