Fiscal Policy

Question 1

Contractionary FP

Answer 1

Reducing aggregate demand by reducing govt. spending or tax increases.

Question 2

Expansionary FP

Answer 2

Boosting aggregate demand by increasing govt. spending or lowering taxes.

Question 3

Tools of Fiscal Policy

Answer 3

Manipulation of Govt. Spending
Taxation
Budget balance

Question 4

Automatic Stabilisers

Answer 4

When policy automatically reacts to changes in the economic cycle

1. During a recession - Govt. spending increases via increased welfare payments but tax rev decreases leading to a budget deficit
2. During a boom - Govt. tax rev increases and govt. welfare payments fall - leading to a buddget surplus

Question 5

Evaluation of Automatic Stabilisers (3)

Answer 5

Impact depends on whether a government allows the automatic stabilisers to operate fully - ie. austerity policy

Impact depends on the relative generosity of the welfare system such as base levels of payment for universal credit and unemployment support. Some governments have capped total welfare payments.

Impact depends on the marginal propensity to spend and save of those households whose income is boosted by welfare during a recession.

Question 6

Discretionary Policy

Answer 6

Govt. deliberately change their level of spending + tax.

1. At any given point, Govt. can choose to improve infrastructure etc. and increase tax to do so.
2. Govt. may take action due to the economic cycle.

Question 7

Structural Budget Position

Answer 7

The long-term fiscal stance - ie. during the whole economic cycle.

Question 8

Cyclical Budget Position

Answer 8

The short-term fiscal stance - ie. affected by the economic cycle

Question 9

Types of Govt. spending

Answer 9

1. Current Expenditure - Immediate spending, eg. wages
2. Capital Expenditure - Spending of Long term assets eg. infrastructure projects.

Question 10

Cannons of Tax (4)

Answer 10

Canon of Equity - Taxation should be equitable or fair, meaning that those who are wealthier should contribute more and taxes shouldnt penalise the poorest in society.
Canon of Certainty - Those who pay tax should be able to predict how much they will pay to enable them to plan expenditure. Govt. should be confident in tax revenue forecasts.
Canon of Convenience / Simplicity - Tax should be convenient and easy to plan, meaning tax is paid at the same time each year/month and tax should be easy to calculate.
Canon of Economy - The cost of tax collection should be lower than the amount of tax collected or the very purpose of applying tax has been undermined.

Question 11

Golden rule of Fiscal Policy

Answer 11

Only borrow to invest in capital over the course of an economic cycle, hence funding long-run growth by increasing capacity.

Do not borrow to finance current expenditure

Question 12

Horizontal Equity

Answer 12

People who have similar income and abilities should pay the same amount tax.

Question 13

Vertical Equity

Answer 13

People earning higher incomes and with greater abilities should pay more tax than those on lower income.

Question 14

Progressive Taxation

Answer 14

Tax paid increases as an individual’s income increases (eg. Income tax) , a useful tool to redistribute income and reduce poverty

Achieves vertical equity

Question 15

Regressive Taxation

Answer 15

Tax paid falls are income rises. By reducing the tax rate on the rich, the Govt. aims to promote supply-side growth (trickle-down economics) + incentive to work harder to reduce tax burden

Increases inequality

Question 16

Proportional Taxation

Answer 16

Everyone pays the same proportion of tax regardless of income (eg. VAT).

Horizontal Equity

Question 17

What affects the size of Govt. Spending ?

Answer 17

1) Size + Structure of the population
2) Political Objectives
3) Policy on inequality / poverty / redistribution
4) Fiscal Policy

Question 18

Public Sector Net Cash Requirment (PSNCR)

Answer 18

When UK Govt. spends more than it receives in revenue then the Govt. must borrow this money.

aka a budget defict

Question 19

Public Sector Debt Repayment (PSDR)

Answer 19

When UK Govt. receives more in revenue than it spends, the Govt. can repay this debt.

Question 20

Causes of a budget deficit

Answer 20

Rising unemployment - falling tax rev
Low levels of demand / profts - falling tax rev
Excessice Govt. spending / borrowing
Population demographic - eg. aging population
Increasing welfare payments

Question 21

Key consequence of a budget deficit

Answer 21

Excessive borrowing (PSNCR) - Growing national Debt

Question 22

Positive Effect of Increasing National Debt

Answer 22

Merit goods such as education and training or healthcare
Public goods such as roads or defence
Welfare benefits/social provision
The redistribution of income/wealth
Infrastructure
Supply-side policies
Crowding in

Question 23

Negative Effect of Increasing National Debt

Answer 23

Crowding out
Lower credit rating for UK
Possible inflationary pressure
Intergenerational inequality
Reduced FDI

Question 24

The Office for Budget Responsibility (+ 3 key roles)

Answer 24

The office for budget responsibility is an independent body that was created in 2010 that helps to keep Govt. fiscal policy under control. Their role includes;

Publishing reports that analyse the UK Govt.’s use of taxation, spending and evaluates Govt. future spending predictions.
Assess Govt. fiscal performance against Govt. targets and objectives.
Uses long-term projections to analyse the sustainability of Govt. spending.

Question 25

Microeconomic impact of FP

Answer 25

Government policy influences microeconomics by implementing incentives and inputs that shape individual decisions.

Question 26

Relationship between budget and debt

Answer 26

When the Govt. spends, their budget deficit worsens and their long-term debt increases.

Question 27

Cyclical Budget Deficit

Answer 27

The size of the budget deficit is determined by the state of the economy, eg. economic cycle position

Question 28

Structural Budget Deficit

Answer 28

Budget deficits that persist during times of boom due to structural issues within the economy.

Question 29

Crowding Out Effect

Answer 29

Where excessive Govt. investment into the private sector deters private investment.

Question 30

Crowding In Effect

Answer 30

When govt. investment in the private sector promotes further private sector investment due to growing confidence

Question 31

Crowding In vs Crowding Out

Answer 31

Crowding in is more likely to occur in a recession when the private sector has unused savings. Crowding in may prove to be a temporary effect.

Crowding out will occur when the economy is close to full capacity and limited spare savings.