fiscal policy Flashcards
what is fiscal policy
fiscal policy refers to the use of government spending and taxation to influence the economic environment
How much money has Rishi Sunak invested in education.
£96 billion has been used for tutoring and catch up lessons for the work missed out in lockdown
What are the two benefits in a fall in income tax?
- Increased incentive to work
- Greater disposable incomes leading to greater consumption.
- Trickle down effect- as those high income earner earn more the may chose to invest
Economic activity
The activity of making, purchasing and selling of goods and services
reasons for an expansionary fiscal policy
- boost growth
- reduce unemployment
- redistribute income
reasons for deflationary fiscal policy
- reduce inflation
- reduce budget deficit
- reduced current account deficit
how can a deflationary fiscal policy cause a current account surplus
with increase taxes incomes are likely to fall and people are less likely to import as a result
what is a budget deficit
the amount the the government has to borrow each year as a result of G spending> G Income
what is national debt
the total amount of money that the government owes to private sector and other purchasers of UK gilts.
negatives of running a budget deficit
(crowding out analysis
when the government runs a high budget deficit for a long time and needs to borrow money it will issue more government bonds
with an increase in supply the market price for bonds falls and the yield may exceed 1% (current bank rate)
The government may finance their debt in the short term
But as banks chose to buy bonds therefore decreasing their supply of money falls meaning less loans can be lent out at a lower interest rate. This may cause interest rates to rise and investment may fall as a result.
draw the crowding out diagram
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when may crowding out be particularly harmful
when recovering from a recession such as covid.
when may operating on a budget deficit be ok
(structural). the golden rule says the government is able to borrow as long as it funds capital spending such as investment on the HNS or the HS2
as it improves the quality and quantity of the workforce therefore shifting out lras
(cyclical). when avoiding deflation and the real wage unemployment associated with it (hysteresis)
how to calculate the yield on bonds
yield= (coupon/market price)X100
Cooper is always on top
why may crowding out be particularly likely in the UK
as the bank rate is currently at 0.75% many banks will chose to invest in bonds which have a higher coupon
what the relationship between the market price and the yield of a bond
as its an inverse relationship
how much money did the furlough scheme cost the government
the government spent 70 billion pounds on the furlough scheme
what is the UKs national debt as a percentage of GDP
96%
negatives of running a budget deficit
- intergenerational inequality
- falling credit ratings
- crowding out.
examples of interventionist market failure
- hs2
- education and vocational training
- health care
market based supply side policies
- privatisation- creates profit motive
2. deregulation
problems with privatisation
- may cause mass unemployment as firms seek to make profit gains and cut labour costs
labour market policies
- reduce income tax
- reducing welfare benefits
- reducing the power of trade unions
- removing the NMW
what causes the economic cycle
- fluctuations in ad
- external shocks
- multiplier
conflict of actual growth
demand
- demand pull inflation if there is no spare capacity
- balance of trade deficit (assuming its not export led growth)
- high national debt (if fiscal stimulus is being used)
- inequality (if tax system isn’t progressive).
Problems with removal of trade unions and NMW
workers may be exploited without them
why is falling credit ratings negative for the UK government
Moodys have downgraded credit ratings from Aa2 to Aa3 following the uncertainty caused by Brexit.
This may make government borrowing harder as investors may be less trusting that they will get repaid.
When demand is low for bond the yield increases on existing bonds making new bonds less attractive and government debt more expensive
This may harm economic development and less spending in goods such as education is likely
examples of countries that have a credit rating of AAA
Germany
Australia
Netherlands
Canada
Investors may instead chose to buy these government bonds and development and economic growth may improve here
evaluation of the credit raters
These credit raters have imperfect information and a country may be down graded unfairly
only Moodys down graded the UK whereas the other didn’t
what does the government need to consider when choosing to run a budget deficit
- current national debt (94% of GDP which is the highest value since the 1960s)
- how big the negative output gap is
- how effective monetary policy is
cyclical budget deficit
a budget deficit that is dictated by the economic cycle
Eg less tax revenue is earned as business make less profits and more unemployment benefits are required
why are we not worried about a cyclical budget deficit
as it is an automatic stabiliser
as earnings increase as a result of the fiscal stimulus the economy may experience fiscal drag.
Increased earning= increased tax revenue= repaid budget deficit
structural budget deficit
one that happens at full capacity
how can lowered tax improve the supply side of the economy
- increases incentive to work as workers can keep a larger percentage of their income
- encourages workers to get training and education to get the jobs they wanted increasing the quality of the workforce
- this increases the supply of labour increasing the competition for jobs
- firms could lower wages and produce the same amount at a lower cost
causes of a structural deficit
- fiscal stimulus (such as the furlough scheme)- even when the economy recovers the government will still owe the spending on fiscal spending
- ageing population- increased spending on pensions.
- Dutch disease- when the government builds when the economy is rich but can’t continue to finance spending when economy is poor
explain the dutch disease
the dutch economy was reliant on tulips.
a rise in tulip prices meant that many firms earned higher profits meaning tax revenue increased
this financed government spending
when the price of tulips fell the government no longer had access to tax revenue and they became less able to finance the public spending
evaluation of a structural deficit
- how much is being spent (less than 3% of GDP)
2. what it is being spent on
why is the cost of borrowing so low.
- QE has increased the demand in secondary markets
- market value of bonds increases
- this pushes the yields down
- so new debt could be issued at a lower coupon
- years of low bank rates increases asset prices.
- savers withdraw they cash to invest in bonds
how expensive have debt interests been
since 2020 the Government has been spending around £800 million pound on interest payments
