Fiscal Policy

Question 1

What are the three budget outcomes?

Answer 1

If revenue = expenditure, the budget is in balance
If revenue > spending, the budget is in surplus
If revenue < spending, the budget is in deficit

Question 2

How are government bonds used to finance a deficit?

Answer 2

A bond is a financial instrument which raises funds for its issuer in return for a rate of interest payable to the buyer. The government raises money to finance a budget deficit through selling government bonds

Question 3

In what ways can a government use funds from a budget surplus?

Answer 3

A surplus can be used to pay off government debt built up by past deficits

Question 4

Explain how government revenue and expenditure automatically change when the economy is in a boom

Answer 4

When the economy is in a boom, tax revenue rises and welfare payments, so the budget balance becomes increasingly positive

Question 5

Suggest three specific measures the government could use to ‘increase government expenditure’ or ‘decrease revenue’ to boost spending in a sluggish economy

Answer 5

In a period of slow economic activity, it is appropriate to use an expansionary budget to stimulate spending. Policies include: reducing income tax to increase purchasing power, cutting corporate tax to stimulate business spending, and increasing government spending on infrastructure such as transport projects.

Question 6

Explain the term ‘cyclically balanced budget’

Answer 6

Cyclical balance is the balance between revenue and spending

Question 7

Distinguish between the structural and cyclical components of the budget

Answer 7

The discretionary changes to government spending and tax determine the structural balance
The automatic stabilisers determine the cyclical balance

Question 8

What factors may determine the extent of any ‘crowding out’?

Answer 8

When increased interest rates lead to a reduction in private investment spending, dampening the initial increase of total investment spending is called crowding out effect
The greater the interest rate increases when the Government spending increases, the greater will be the crowding out.

Question 9

What are the strengths of fiscal policy?

Answer 9

Direct
Can be implemented immediately
Its effect on the economy during a recession

Question 10

What are the weaknesses of fiscal policy?

Answer 10

Time lags
Inflexible
Political restraints